Over the last five years, the dominant regulatory trend in global compliance has been the spread of legislation which mandates companies to carry out Human Rights and ESG Due Diligence (HRDD) on third parties and suppliers. This has significant implications for any company operating in a jurisdiction with HRDD regulations–or whose third parties and suppliers operate there. In the latest blog in our Third Party Risk Series, we explain why responding to this trend should be a priority for your company–and how LexisNexis can help.
HRDD has transformed the global regulatory landscape
The most obvious reason why firms should pay attention to ESG regulations is that the trend has already made a major change to the global regulatory framework, and appears to be here to stay. Some of the world’s largest economies now require companies to assess their third parties and suppliers for ESG risks. For example:
- Germany’s Supply Chain Due Diligence Act, which came into force in January 2023, mandates regulated companies above a certain size to carry out due diligence and risk management to mitigate human rights violations in their supply chains.
- In the US, the Uyghur Forced Labor Prevention Act presumes that all goods produced in Xinjiang, China, came from forced labour. As a result, companies cannot import these goods to the US unless they can prove through due diligence that forced labour was not involved.
- EU: The Corporate Sustainability Due Diligence Directive is now in its final stages of negotiation and expected to take effect next year. It will require regulated companies operating in EU member states to ensure activities by the business and its suppliers comply with strict human rights and environmental sustainability criteria.
There has also been a trend towards regulators requiring financial companies to make disclosures about their efforts to improve their ESG record. For example:
- Switzerland’s Responsible Business Initiative of 2022 mandates large and listed companies supervised by the Swiss Financial Market Supervisory Authority to publish an annual report on their ESG record.
- France: Investors must declare the environmental credentials of their assets and set greenhouse gas emissions and biodiversity goals every five years.
- Hong Kong: In December 2022, new requirements were introduced for banks to meet standards for managing climate risk, and make appropriate disclosures to the regulators on this activity. Mandatory climate reporting is being considered for all financial institutions by 2025.
Moreover, the trend towards human rights and ESG regulation does not seem to be slowing down. More and more countries have proposed, or are considering, legislation and regulation which mandates companies to address human rights and ESG issues. For example:
- Canada’s Fighting Against Forced Labour and Child Labour in Supply Chains Act will come into force in early 2024. It requires businesses to report annually on evidence of forced labour in their supply chains.
- The UK government has proposed an updated Modern Slavery Bill which would require firms to publish statements which outline their due diligence process and spell out their assessment of modern slavery risks, and the steps taken to mitigate them. This would strengthen the Modern Slavery Act of 2015, which already requires large companies to publish an annual statement on their efforts to tackle human trafficking or modern slavery in their supply chain.
Addressing HRDD requirements means an overhaul of your due diligence approach
HRDD legislation is so consequential for firms it is likely to change the way they approach compliance and due diligence. Traditionally, a typical due diligence process sought to rule out any legal or financial issues in a third party. Now, this process needs to be expanded so that compliance officers can accurately assess a firm’s ESG record too.
But improving your firm’s understanding of its third parties’ human rights and ESG records is not simply about avoiding regulatory attention. Demonstrating that your company has effective oversight of all its third parties and suppliers, and is able to root out any suspicion of ESG failures and take action, has also been proven to drive commercial success. This is because growing numbers of customers, employees and investors want to buy from, work for and invest in firms with a positive effect on society. This trend is predicted to continue because, as a recent survey by Harris Poll found, young people have the highest expectations for companies to behave ethically.
What should companies do?
The best way for companies to survive and thrive in an era of HRDD legislation is by improving their management of third party risk. This means starting with a due diligence process that is capable of assessing all third parties for ESG risk, as well as more traditional financial and legal risks.
Acquiring the most relevant data is the first challenge firms face. Assessing ESG risk requires a wide range of trusted data sources, including news coverage going back decades, company data, legal data, PEP data, and more. Technological tools can bring this data together in one place, and automatically search for mentions of a third party–a process which would take a vast amount of staff time if done manually. Platforms such as Nexis Diligence+
can leverage technology to search across all of these datasets and more, to produce a risk score and an ESG rating for each one of your third parties.