Supply Chains in the Spotlight: The role of supply chain (disclosure) regulations

Berlin, April 2022

Supply Chains in the Spotlight:

The role of supply chain (disclosure) regulations AN ANALYSIS BY CLIMATE & COMPANY

Authors Katharina Erdmann Malte Hessenius Mustafa Yahsi

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ABSTRACT Most of the negative environmental impacts resulting from EU manufacturing and retail take place in the supply chain. Two legislative EU proposals have the potential to be a gamechanger towards more sustainable supply chains: the proposal for a Regulation of Deforestation-free Products and the proposal of the Sustainability Due Diligence Directive. The latter is in particular promising as it includes due diligence and reporting requirements for roughly 12,000 companies. In this analysis, we demonstrate that the current availability of

supply chain data to identify risks and opportunities and reduce market inefficiencies is limited (and therefore requires more regulation). Moreover, we examine the scope of the proposed Corporate Sustainability Due Diligence Directive and find that the initial sector selection is a good approach but that

more transparency could be achieved by identifying further high-impact sectors and by adjusting sectorspecific thresholds to capture more economic activity (and corresponding environmental impact) via the proposed regulation.

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INTRODUCTION Most of the negative environmental impacts resulting from EU manufacturing and retail takes place in the supply chain. Especially industries like fashion, food (high upstream impact), or the chemical and the car manufacturing sectors (high downstream impact), harm the environment by the emission of greenhouse gases, air and water pollution, unsustainable land use and habitat change or unsustainable levels of water consumption (Jungmichel, Schampel and Weiss, 2017).

Awareness about global supply chains and their impacts (and dependencies) on various environmental aspects is slowly (but surely) rising. An increasing number of countries 1 has already implemented (or is about to implement) supply chain laws to enhance due diligence and transparency about the indirect or embedded externalities of corporate activities; however, so far, these are mostly focusing on the S (social) dimension of ESG (environmental, social and governance) performance of companies and in particular human rights violations rather than targeting the environmental dimension.

Transparency is key. From a sustainable finance perspective, corporate disclosure is the starting point since it increases transparency and obliges companies to understand, measure and report their supply-chain related impacts and dependencies ( ). Transparency through corporate disclosure helps to identify risks. These can be physical (e.g., the risk of extreme weather events or dependencies on intact ecosystems and their services ) or transitional (e.g., regulatory ban of unsustainable products, pricing of externalities, such as carbon emissions). Moreover, it also helps to keep track of international sustainability objectives, such as the Paris Agreement or the Sustainable Development Goals (SDGs), relevant for policy makers, civil society, but also impact investors interested in the sustainability

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performance of their portfolio companies. As of today, the transparency along the supply chain is low (CDP, 2022) and it is highly unlikely that a sufficient level of transparency with comparable and complete data availability can be achieved with voluntary disclosure alone instead it requires mandatory regulation (Habek and Wolniak, 2015).

Two legislative European Union (EU) proposals have the potential to be a gamechanger towards more sustainable supply chains: the proposal for a Regulation of Deforestation-free Products and the proposal of the Diligence Directive. The former is an attempt to ban products linked to deforestation from EU markets (such as soy, coffee, beef, palm oil, among others), thereby minimizing the impact of EU consumption on the is a recent proposal (February 2022) and a comprehensive attempt for Corporate Due Diligence addressing both social and environmental aspects. Both proposals also contain disclosure requirements and should therefore foster the transparency across the whole value chain (while it is crucial that these requirements are well aligned with existing EU sustainability disclosure requirements).

However, the proposed Regulation and the Directive are still under discussion and subject to changes.

Under the existing EU sustainability disclosure regime, EU companies need to report under the Nonfinancial Reporting Directive (NFRD). However, supply chain disclosure is hardly covered and according to an impact assessment of the European Commission, it has not resulted into a change of corporates (disclosure) policies along the supply chain 2.

While the proposed Corporate Sustainability Reporting Directive (CSRD), the successor of the NFRD, poorly specifies supply chain disclosure, the emerging

Such as the United Kingdom, Germany or France. More details in the next section.

European Commission (2021), link 3

reporting standards 3 already include references to value chain related risks and impacts in the draft disclosure requirements. The Taxonomy Regulation presents a classification system for sustainable economic activities and also requires additional corporate disclosure. The recently published draft criteria 4 for the environmental objectives beyond climate change mitigation and adaptation do not (yet) come with a coherent approach to considering supply chain effects. 5 Against the background of the importance of transparency along the supply chain and the recent regulatory developments in the EU, we explored the following two research questions: •

What is the state of commercial supply chain data? (see Figure 1)

•

According to the current legislative proposals, what is the sectoral distribution of companies falling under the scope of the proposed supplychain related EU legislation? And how much of the entire economic activity (and corresponding environmental impact) is captured by the regulation? (see Table 1 and Table 2)

The remainder of this policy brief is structured as follows.

The first section provides background information on existing supply chain laws, presents the new EU regulatory proposals, and explains how they should foster transparency. Based on this, an initial analysis of available firm-level (supply chain) data attempts to contribute to answering the aforementioned (research) questions. We conclude with our main findings and identify a set of next steps and pertinent open questions.

Currently, the European Financial Reporting Advisory Group Project Task force on European Sustainability Reporting Standards (EFRAG PTF ESRS) undertakes this work in support of the implementation of the CSRD. It will form the basis of the delegated acts the Commission will have to adopt to specify and fully implement the CSRD. 4 EU Platform on Sustainable Finance (2022), link 5 The development of the technical screening criteria is currently undertaken by the EU Sustainable Finance Platform, in support of the implementation of the EU Taxonomy Regulation. Some of the sector/activity specific draft criteria include 3

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EXISTING SUPPLY CHAIN (DISCLOSURE) REGULATIONS Regulations fostering the transparency of sustainability issues are a dynamically evolving field, driven in particular by an increasing interest of investors and financial institutions in general to improve their understanding of risks and impacts related to their investments. All over the world, disclosure regulations are being developed and implemented. Our recent international study on ESG disclosure regulations, with an in-depth analysis of 20 jurisdictions (IPSF, 2021), found that: •

policy makers and regulatory authorities are increasingly turning voluntary ESG disclosure standards into mandatory regulation;

•

the scope of entities subject to mandatory regulations mainly consists of large, publicly listed companies;

•

the explicit inclusion of forward-looking and supply chain disclosure in (mandatory) regulation are still rare but emerging.

Although often overlooked and still in its infancy, disclosure (regulation) on the supply chain is getting some traction. Examples of existing regulations are the following: •

In the United Kingdom, the UK Modern Slavery Act 2015 6 aims to increase controls along the entire supply chain to combat human rights violations. It also involves the preparation of a

slavery and human trafficking statement for each financial year.

•

In France, the French due diligence law from 2018 7 requires large entities to publish and implement a surveillance plan to assess, monitor and reduce social and environmental risks along the value chain. Similar regulations also exist in the Netherlands and Switzerland.

•

Germany adopted its supply chain law 8 in summer 2021, which will enter into force in January 2023 and focuses on human rights due diligence considering tier 1 supplier only.

•

Beyond Europe, California, for instance, has implemented the Transparency in Supply Chains Act 9 . It requires large retailers and manufacturers operating in California to disclose information about the efforts to prevent and root out human trafficking and slavery in their supply chains.

•

In Canada, the modern slavery bill 10 will require listed companies that meet certain criteria to report on human rights issues along the supply chain.

Most existing regulations focus on human rights; however, two EU legislative proposals also prominently address environmental risks and impacts along the supply chain: The Regulation of

United Kingdom (2015), link Republic of France (2017), link 8 Deutscher Bundestag (2021), link 9 State of California, link 10 Parliament of Canada, link 6 7

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Deforestation-free Products and the Sustainability Due Diligence Directive.

Corporate

adverse impacts increased and corporate actions improved.

If implemented and enforced properly, both proposals have the potential to a) increase companies responsibility and need to manage their supply chain risks and impacts, b) improve transparency through respective disclosure obligations, and c) improve realworld sustainability impacts and (companies) performance by reducing the impact on the environment and on people (workers and communities more broadly). However, with both regulatory files still being in a proposal stage, this would require the colegislators to support the ambition, rather than proposing dilution and procrastination, which is what 11 characterizes both the and the 12 first reactions to the .

The focus of the proposed legislation are environmental and human rights due diligence obligations along the entire value chain. This means that it applies to the own operations, their subsidiaries, and their supply chain. The proposal suggests that affected companies will be required to

Corporate Sustainability Due Diligence Directive EU ) In February 2022, the European Commission published its much-anticipated Corporate Sustainability Due Diligence Directive 13 - the . If adopted as proposed, it would apply to EU companies with more than 500 employees and a global net turnover of over companies (over 250 employees and 40 million turnover) are targeted if they operate in a high-impact sector (i.e., textiles, agrifood, and extractives 14). Non-EU companies operating in the single market are covered as well if they exceed the turnover thresholds above (for revenue generated in the EU). The Directive shall ensure a more effective protection of human rights and a reduction of negative environmental impacts along the supply chain. According to the calculations of the European Commission, about 13.000 EU companies and 4.000 non-EU companies would fall under the scope of the Regulation.15 By introducing an EU-wide law, a fragmentation of due diligence requirements across EU countries should be avoided, accountability for

•

integrate supply chain due diligence in their policies;

•

identify social and environmental adverse aspects along the supply chain;

•

prevent/ mitigate potential impacts and stop/ minimize actual impacts;

•

set up and manage a complaints procedure;

•

monitor the effectiveness of all measures.

To also enhance transparency and public communication on this topic, companies will be required to disclose their due diligence strategy. This includes the description of the company´s due diligence approach, a code of conduct to be followed by the employees and subsidiaries, and an implementation plan (draft article 5). According to the draft article 11, the European Commission shall draft delegated acts to specify the exact reporting obligations. Moreover, the European Commission plans to publish sector-specific guidelines to support companies.

The proposed law shall be closely linked to other EU (disclosure) policies. The proposed Corporate Sustainability Reporting Directive (CSRD) mandates entities to disclose their transition plan to a sustainable economic activity, in line with limiting global warming to 1.5 °C. On the one hand, the EU supply chain law will facilitate the information collection for the reporting obligations under the CSRD and will lead to a more complete reporting. On the other hand, the supply chain law goes beyond reporting obligations and demands due diligence. Hence, companies would be expected to increasingly take actions against adverse impacts along their supply chain. In addition, the (reporting on the) EU

European Council (2022), link European Parliament (2022), link 13 European Commission (2022), link 14 For the exact wording about the proposed scope, refer to article 2 (ibid.)

15 Ibid.

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Taxonomy Regulation already includes minimum social 16 safeguards, while the presented by the EU Sustainable Finance Platform in February 2022 (carefully) sketches a possible way forward for the European Commission toward developing a proper social taxonomy. As the proposed Supply Chain Directive, the minimum safeguards build on the United Nations Principles on Business and Human Rights.17 The Commission´s draft is considered to be an ambitious proposal (Handelsblatt, 2022). However, experts on the other hand criticized the limited scope of the Directive, as 99% of all EU companies (mostly SMEs) will not be covered. SMEs represent, for some environmentally extremely relevant sectors like agriculture or construction, the bulk of economic activity (WPSF, 2021). Further, the draft focuses on nonfinancial companies and hardly considers financial institutions. The chapter below will further analyse which companies fall under the proposed Directive.

EU Regulation on Deforestation-free Products

deforestation-free products are sold in the EU market.

More concretely, the proposed Regulation •

sets mandatory due diligence rules for corporates selling specific commodities in the EU market (e.g., soy, beef, palm oil) to ban deforestation-linked products;

•

requires operators to collect geographic coordinates of the origin of the commodities which are placed on the EU market;

•

will distinguish between low, standard and high risk countries.

The proposal has attracted much attention and the public consultation gathered 1.2 million responses 18 (the second most popular in EU history after consultation on the summertime 19). Nonetheless, there the proposed Regulation (WWF, 2021). For example, other natural ecosystems, such as grasslands or wetlands, are not included yet and products from lowrisk countries can enter the European market easily.

Further, not all high-risk products are covered in the proposal. Beyond the due diligence obligations, the proposed Regulation also includes reporting obligations (draft article 11 and 19) which requires companies to report on the application of the Regulation annually. 20

deforestation law attempts to ban products linked to deforestation from EU markets (such as soy, coffee, beef, palm oil, among others), thereby minimising the impact of EU consumption on deforestation. It applies to any company that places certain commodities on the EU market. A high level of deforestation is alarming due to several reasons: the loss of biodiversity, the crucial role of forests to limit the temperature rise to 1.5° Cel sius or further environmental risks, such as pandemics (IPBES, 2019). The proposed Regulation shall ensure that only

EU Sustainable Finance Platform (2022), link CSRD, see here and Taxonomy Regulation see here.

18 European Commission (2021) link 19 European Commission (2018), link 20 More concretely out on operators and traders, including the contents of these checks, the volume of relevant commodities and products checked in relation to the total quantity of relevant commodities and products placed on the market, the countries of origin and of production of relevant commodities and products as well as the measures taken in case of non-compliance and the 16 17

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DATA ANALYTICS: DATA AVAILABILITY AND EU SUPPLY CHAIN LAW Data availability of Tier 1 suppliers where do we stand?

For financial institutions and analysts, one of the core information that is needed to run a comprehensive dependencies across their supply chain is, at least, information on their tier 1 suppliers (i.e., their direct suppliers). This enables an analysis of where the company of interest is getting their products from (suppliers) and where they are selling to (customers). As of now, only a few companies disclose this information comprehensively. One example is Nestle who just recently disclosed an extensive list of their suppliers, covering 95% of its annual sourcing of raw materials 21. Unilever, as another example, discloses 99.9% of soy oil purchases 22 and 85% of tier 1 and tier 2 cocoa suppliers 23.

Data providers have responded to that data need by levering intelligent machine-learning algorithms to extract supplier-customer relationships from various (unstructured) sources, such as annual reports and websites: E relationships 24 global supply chain data 25 . Although the provided data might not be fully accurate, e.g., due to minor errors in the algorithm or time lag of the analysis, these data products give a first order of magnitude on what is disclosed today. Investors heavily rely on data providers to acquire easily

accessible, reliable, and comparable data (Amel-Zadeh & Serafeim, 2018).

To obtain an overview of the data availability of supplier-customer relations, the histogram below (Figure 1) shows the distribution of the number of disclosed suppliers for a sample of publicly listed EU companies. It thus displays the density of companies depending on how many tier 1 suppliers they disclosed (or how many supplier relationships the data provider, in this case FactSet, was able to extract)26. For the vast majority of the sample firms (85%), the data supplier states 10 or less than 10 suppliers. Reasons could be a low number of suppliers, an incomplete data extraction

by FactSet, a low level of disclosure, or a possible combination of these factors. In the context of complex supply chains, we can conclude that the data availability of suppliers from this data provider is arguably limited for EU firms. This implies that investors are not able to easily gather information on customer-supplier relationships and that transparency remains low. Since regulation is one important driver of data availability (Juergens and Erdmann, 2019), the proposed EU Corporate Sustainability Due Diligence Directive could be an important building block for a higher level of transparency.

Nestle, link Unilever, link 23 Unilever (2020), link 24 FactSet, link 25 Bloomberg, link 26 Overall, FactSet data provides direct and current relationships (e.g., customer, supplier) for 2,903 listed EU companies, i.e., for less than a half of listed EU firms. For 1,156 out of those 2,903 listed EU companies (~40% of covered firms), FactSet provides data on the on-going relationships with their suppliers which forms the sample for this histogram.

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Figure 1 - Number of disclosed suppliers for a sample of EU firms27

Deep Dive and data analytics: EU Supply Chain Law In its proposed form and as stated above, the Corporate Sustainability Due Diligence Directive targets approximately 12,800 EU and 4,000 non-EU companies 28, according to the following criteria: •

Group 1, the sector-agnostic thresholds: EU companies, with more than 500 employees and a global net turnover of over million.

•

Group 2, the sector-specific thresholds targeting high-impact sectors: EU companies with more than 250 employees and 40 million turnover if they operate in a high-impact sector29.

•

Non-EU companies if they generate more than 150 million EUR turnover in the EU or if they generate at least 40 million EUR turnover in the

Source: FactSet. Sample: Publicly listed companies, headquartered in the EU, with a total sample size of 1,156 companies.

European Commission (2022), link 29 See Article 2 of the EU Corporate Sustainability Due Diligence Directive: manufacturing and wholesale of textiles, agriculture, forestry and fisheries as well as manufacturing of food products and wholesale of food-related products; plus extraction, manufacturing and trade of mineral resources.

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•

EU with at least 50% in one of the high-impact sectors (see Article 2, paragraph 1, point b).

Table 1 shows that the largest portion in that sample is manufacturing companies, contributing ~40% of the (in-sample) revenue, followed by wholesale (~15%) and finance (~13%). Especially the agricultural sector is not well represented in the first group of companies, with only 0.3% of the insample revenue.

For a more comprehensive overview of the affected companies, the sectoral distribution, and the share of economic activities needs to be examined. In the following we present two tables: •

Table 2 presents how much of the total EU economy is covered by the EU supply chain law (for selected sectors).

Table 1 presents the sectoral distribution of companies captured by sector-agnostic criteria .

Table 1 - Sector distribution according to the sector-agnostic thresholds SECTOR (following the NACE classification)

Firms

Firms

Revenue

Employees

#

% of Sample

% of Sample

% of Sample

A - Agriculture & Forestry A

83

0.8%

0.3%

0.4%

131

1.3%

1.3%

0.7%

2838

28.9%

38.8%

24.9%

D – Electricity

173

1.8%

7.3%

2.5%

E – Water

152

1.5%

0.7%

1.1%

F – Construction

406

4.1%

2.8%

2.6%

1335

13.6%

15.7%

13.4%

H - Transportation and storage

543

5.5%

4.0%

5.4%

I - Accommodation & Food Serv.

287

2.9%

0.6%

2.6%

J - Information and Comm.

663

6.7%

7.5%

7.0%

K - Financial and insurance

783

8.0%

13.6%

8.4%

98

1.0%

0.3%

0.3%

2337

23.8%

6.8%

30.8%

9829

100%

100%

100%

B - Mining & quarrying A C - Manufacturing A

G - Wholesale, Retail trade, Repair of vehicles A

L - Real Estate OTHERS 1 SUM Source : Refinitiv. Sample: Companies that meet the

> 150 million).

1) NACE sectors M-T (Scientific activities, Health Sector, Administration, Consulting etc).

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2) Sum does not equal 9,400 (number disclosed by EU Commission). The reason for that is most likely inconsistent data sources.

A) Further companies will be included via the sector-specific thresholds.

However, from the perspective of environmental regulation and sustainable finance, the EU Corporate Sustainability Due Diligence Directive should capture larger parts of economic activity in sectors with a high impact on the environment (along their supply chain). The EU aims to consider this by the introduction of lower thresholds for some sectors that are part of the supply chain of textiles; agriculture, forestry and fisheries; and mineral resources and basic metals, among others (i.e., the sector-specific thresholds, companies from Group 2).

What are high-impact sectors? In this context, it is important to differentiate between impacts origination direct operations and impacts originating from their supply chain. For most economic sectors, direct operations are responsible for only a relatively low percentage of the natural capital costs compared to supply chain where natural capital is considered as the combination of assets that are nonrenewable and traded (e.g., fossil fuel) and those that provide finite renewable goods and service (e.g., biodiversity). The State of Green Business report 30 provides a first its natural capital costs originating from its direct operations and its supply chain. On average, supply chain activities are accountable for 80% of the total natural capital costs across sectors. The sectors with the highest ratio are, among others, food, beverage and tobacco (Nace A & C); automobiles and components (NACE C); and retailing (NACE G, in particular food and staples retailing). A report by McKinsey highlights the high natural capital impact in supply chains in the consumer sector and in particular food and beverage, personal and household goods, and retail 31 . A study focusing on the biodiversity footprint of Dutch economic sectors identified a high impact along the supply chain for food, beverages and tobacco; textiles and leather;

wood and products of wood; basic metals; machinery; electrical and optical equipment; construction, among others (Wilting and van Oorschot, 2017). Further studies exist (e.g., Jungmichel et al., 2017) and present a more comprehensive analysis than in this short overview.

Another study (Kurth et al., 2020) looks at this from a different angle and estimates the distribution of total pressure on biodiversity by the direct operations of economic sectors. The study demonstrates that Nace Agriculture, Fishing is accountable for an overall estimated 59% of the pressure on biodiversity (agriculture, fishing, and forestry have around 26%, 22% and 11% share of pressure on biodiversity, respectively), which highlights the relevance of all sectors that are part of agriculture-, forestry- and fishing-related supply chains (such as manufacture of food, beverages and tobacco (Nace 10,11,12); Manufacturing of textiles, apparel, and leather products (NACE 13,14,15), Manufacture of wood-related products such as paper and furniture (NACE 16, 17, 31, among others); non-exhaustive overview).

To achieve transparency, the EU supply chain law needs to capture large shares of the economic activity (and corresponding environmental impact) in sectors mentioned above by its sector-specific threshold (more selected sectors), if not already covered by the sectoragnostic threshold. Table 2 examines this and presents the number of EU firms and corresponding revenue that would be captured by the Directive. Since retrieving the data for entire sectors (which are comprised of sometimes hundreds of thousands of companies) is time-consuming, we exemplified this analysis for a few selected sectors that are of interest from a climate change and biodiversity perspective 32.

S&P Global and GreenBiz (2021), link, (in particular p.99) McKinsey (2016), link 3232 Electricity (NACE D) is responsible for the largest share of GHG emissions in the EU. Agriculture (NACE A1) ranks third in terms of GHG emissions and has the highest biodiversity footprint worldwide. Land transport (NACE H49), manufacturing of non-metallic minerals (NACE C23), and basic materials (NACE C24) are among the most GHG intensive sectors. Construction (NACE F) is relevant for biodiversity and climate change. And the retail and wholesale sector are in particular relevant from a supply chain dimension (though we were only able to retrieve data on publicly listed companies for that sector).

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Sector-agnostic group SECTOR

Firms #

Firms # Share

1: D - Electricity A

Sector-specific group

(Sector) Revenue

Firms # Share

(Sector) Revenue

Revenue covered and not covered by Directive

72,517

280

54%

-

0%

54%

46%

2: A.01 - Crop and animals A

212,129

34

13%

78

7%

19%

81%

3: H49 - land transport A

308,416

207

38%

-

0%

38%

62%

4: C23 - Nonmetallic minerals A

39,355

149

41%

330

17%

58%

42%

5: C24 - Basic materials A

9,944

183

62%

305

14%

76%

24%

6: F Construction A

320,171

117

31%

-

0%

31%

69%

423

89

69%

12

1%

70%

30%

7: G Wholesale, Retail, etcB

Source: Bureau van Dijk (ORBIS), adjusted from WPSF, 2021 (link), percentages have been rounded Footnotes: A) all listed and non-listed companies, B) only listed companies

What do the numbers tell us? The sector-specific thresholds add additional 17% and 14% of economic activity in Nace C23 (manufacturing, non-metallic minerals) and Nace C24 (manufacturing, basic materials) but only 7% in Nace A.01 (agriculture, animal and crop production). Combined with the sectoragnostic thresholds, the economic activity that is captured differs dramatically: while an estimated 58% and 76% is covered for Nace C23 and C24, it is only 19% for Nace A.01. The reasons for the difference in coverage lies in the sectoral structure. Some sectors, such as agriculture or construction, are traditionally dominated by small- and medium-sized enterprises (SMEs) - instead of large, listed companies. In these sectors, the negative environmental impact originates from many small businesses that contribute little individually (but a lot as a whole). We conclude the following: •

The thresholds work well in rather capitalintensive sectors that are dominated by larger companies.

•

For sectors dominated by SMEs, the majority of economic activity is left out even if sector-

specific thresholds exist (69% in the construction sector, and 81% of crop and animals, for example).

•

Though the proposed Directive is a great starting point, it still contains gaps. Our brief literature and sector screening suggests discussing thresholds that cover more economic activity in the following sectors: wholesale and retail as a whole, the construction sector (due to its direct and indirect impact on nature, its SME structure, and complex supply chain (Antik et al., 2014)), and machinery, electrical and transport equipment.

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CONCLUSION Transparency along the supply chain is the first step towards a more sustainable future. Besides transparency on human rights (violations), it is crucial to improve corporate reporting on environmental aspects.

In many sectors, most of the negative environmental impact results from the supply chain. Transparency enables the identification of risks and opportunities and can help to shift capital flows into more sustainable sources. Several jurisdictions, such as the United Kingdom, France, or the State of California, have already implemented supply chain laws which should, among other objectives, increase transparency. In February 2022, the European Commission proposed the Corporate Sustainability Due Diligence Directive, the It should foster corporate due diligence and transparency along the supply chain. In addition, the Regulation of Deforestation-free Products should ban products linked to deforestation from EU markets. However, to ensure coherency and a sufficient level of ambition, the proposed legislation should be well-aligned with other existing or proposed EU legislation on (corporate) disclosure, mostly the Corporate Sustainability Reporting Directive (CSRD) and the Taxonomy Regulation. EU policy makers should consider specifying this in the further development process of the EU supply chain policy framework.

highest impact on the supply chain are addressed. In this context, we analysed the coverage of the proposed .

Coverage of high-impact sectors by the Our data analysis revealed the sectoral distribution of affected large firms (affected by the sector-agnostic threshold): The majority of firms (over 500 employees and million turnover) belong to the manufacturing, wholesale and retail, or finance sector. The inclusion of a sector-specific threshold in addition is supposed to capture further economic activity in especially relevant sectors. The approach works well in rather capitalintensive industries (17% and 14% additional economic activity captured for manufacturing of non-metallic materials and basic materials) but less for sectors dominated by SMEs (only 7% for animal and crop production). Furthermore, especially for the agricultural and wholesale sector, we identified a low coverage by the proposed Directive, while the environmental pressure is high.

Current data availability on the supply chain Although the awareness on supply chain impacts is increasing, our analytical work shows that data availability on tier 1 suppliers is still limited. An analysis of data provided by FactSet, one of the leading data providers for supply chain information, revealed that only for a small sample of EU listed companies, investors or analysts can access information on their tier 1 suppliers. Regulation can be a driver for an improved data availability. However, this only has an impact if the regulation is designed such that the companies with the

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Suggestions for policy makers

economic activity in high-impact sectors and develop a simplified supply chain reporting standard / due diligence requirement for smaller companies from high impact sectors.

Even though our descriptive analysis is not free from limitations 33 , it indicates some shortcomings of the proposed legislation. We therefore suggest: •

To carry out a more extensive screening of the supply chain impacts across all sectors and environmental topics (e.g., water, pollution and biodiversity). The sectors that are included as part of the sector-specific thresholds are a good start. However, some relevant sectors are not included (for example wholesale and retail as a whole; the construction sector; and machinery, electrical and transport equipment).

•

Based on the above, define adjusted thresholds that capture the majority of

•

In addition to that, transparency through sustainable finance regulations is only the basis for the transformation to more sustainable supply chains. It needs to be complemented with other effective policies to reduce social and environmental harm.

The analysis comes with limitations. The data analysis was only run for a limited number of sectors. Further, elaboration of the high impact sectors is very brief and could be extended by a more comprehensive analysis.

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Jürgens, I. & Erdmann, K. (2020). A Short Qualitative Exploration of the Reporting and Use of Non -Financial Data in the Context of the Fitness Check of the EU Framework for Public Reporting by Companies. Politikberatung kompakt 147.

Available online.

Jungmichel, N., Schampel, C. & Weiss, D. (2017): Umweltatlas Lieferketten. Umweltwirkungen und Hot-Spots in der Lieferkette. Adelphi/Systain. Available online.

Kurth, T., Wübbels, G., Meyer zum Felde, A., Zielcke, S., Vaupel, M., Buschle, M., Krüger, J., Kreiser, K. & Trapp, M. (2020): The Biodiversity Imperative for Business. Preserving the Foundations of Our Well-Being. Available online.

Wilting, H. C., & van Oorschot, M. M. (2017): Quantifying biodiversity footprints of Dutch economic sectors: A global supply-chain analysis. Journal of Cleaner Production, 156, 194-202. Available online.

WWF (2021): EU deforestation law proposal: Off to a strong start, but loopholes must be closed. Available online.

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CREATED BY Climate & Company Ahornallee 2 | 12623 Berlin www.climateandcompany.org | hello@climcom.org

AUTHORS Katharina Erdmann, Malte Hessenius, Mustafa Yahsi

Verantwortlich für den Inhalt nach § 55 Abs. 2 RStV

Version: 1.0, March 2022

Ingmar Juergens & David Rusnok Ahornallee 2 12623 Berlin

ACKNOWLEDGEMENTS Extremely helpful comments and inputs were provided by: Dr. Oliver Herrmann, Climate & Company Ingmar Juergens, Climate & Company

www.climateandcompany.org

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Sector

Firms

(following NACE)

A - Agriculture & Forestry B - Mining & quarrying C - Manufacturing D - Electricity E - Water F - Construction G - Wholesale, Repair of vehicles H - Transportation and storage I - Accommodation & Food Serv.

J - Information and Comm.

K - Financial and insurance L - Real Estate OTHERS1

Revenue

Employees

#

% of sample

% of sample

% of sample

83 131 2838 173 152 406 1335 543 287 663 783 98 2337

0.8% 1.3% 28.9% 1.8% 1.5% 4.1% 13.6% 5.5% 2.9% 6.7% 8.0% 1.0% 23.8%

0.3% 1.3% 38.8% 7.3% 0.7% 2.8% 15.7% 4.0% 0.6% 7.5% 13.6% 0.3% 6.8%

0.4% 0.7% 24.9% 2.5% 1.1% 2.6% 13.4% 5.4% 2.6% 7.0% 8.4% 0.3% 30.8%

98292

100%

100%

100%

Source: Refinitiv. Sample: Companies that meet the conditions of the “Group 1” (EU headquartered, employees > 500, turnover > 150 million).

1) NACE sectors M-T (Scientific activities, Health Sector, Administration, Consulting etc).

2) Sum does not equal 9,400 (number disclosed by EU Commission). The reason for that is most likely inconsistent data sources.

Sector A – Agriculture, Fishing & Forestry B - Mining & quarrying C - Manufacturing D - Electricity E - Water F - Construction G - Wholesale, Repair of vehicles H - Transportation & storage I - Accommodation & Food Serv.

J - Information & Comm.

K - Financial and insurance L - Real Estate OTHERS

# of firms

Belonging to ‘Group 1’ (sector) revenue # of firms share

Belonging to ‘Group 2’ (sector) # of revenue firms share

Revenue not covered by Supply Chain Law

60 119 1948 120 44 294

9 23 555 44 9 60

43% 86% 79% 91% 81% 54%

9 8 227 -

44% 9% 5% 0% 0% 0%

13% 5% 15% 9% 19% 46%

423 145

89 46

69% 72%

12 -

1% 0%

30% 28%

113 875 777 494 700

21 167 154 22 106

86% 80% 90% 48% 69%

-

0% 0% 0% 0% 0%

14% 20% 10% 52% 31%

Source: Refinitiv. Sample: publicly listed companies in the European Union.

1) NACE sectors M-T (Scientific activities, Health Sector, Administration, Consulting etc.)

Sector

# of firms

Belonging to ‘Group 1’ (sector) revenue # of firms share

Belonging to ‘Group 2’ (sector) revenue # of firms share

Revenue not covered by EU Supply Chain Law

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1: D Electricity 2: A.01 - Crop and animals 3: H49 - land transport 4: C23 - Nonmetallic minerals 5: C24 - Basic materials 6: C.20.11 Mnfct Ind Gases 7: F Construction

72,517

280

54%

-

0%

46%

212,129

34

13%

78

7%

81%

308,416

207

38%

-

0%

62%

39,355

149

41%

330

17%

42%

9,944

183

62%

305

14%

24%

543

11

35%

-

0%

65%

320,171

117

31%

-

0%

69%

Source: Bureau van Dijk (ORBIS), adjusted from WPSF, 2021 (link)

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