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07 Dec 2021
BY Koos Pretorius , James Brand AND Mansoor Parker

ESG Objectives |The European Parliament gets serious about obligatory supply chain due diligence investigations

On 10 March 2021, the European Parliament adopted a resolution “EU Resolution” and issued recommendations including a draft directive “EU Directive” in respect of the corporate due diligence and accountability of undertakings with business activities in the EU. Once the EU Directive is passed, it is likely to have far-reaching implications for suppliers of goods and products in countries outside of the EU that sell products or provide services within the EU.

impact on agribusiness SA

These developments in Europe need to be carefully monitored by participants in the South African agribusiness sector who export agri-products to the EU market. From a destination point of view, the African continent and Europe continued to be the largest markets for SA’s agricultural exports, absorbing 38% and 27% of total exports in 2020, in value terms, respectively. The top products to these markets over this period were beverages, fruit, grains, sugar and vegetables.

ESG – what does it mean?

The EU Resolution makes it clear that the European Parliament has embarked on a course which is aimed at ensuring accountability of EU undertakings for any activity that may cause harm to human rights, the environment and good governance, internationally. These considerations are commonly referred to as environmental, social and governance “ESG” objectives. While the EU Directive is still to be adopted, it is clear from the introduction, the wording of the EU Resolution, and the draft EU Directive itself that the future and finalised EU Directive is intended to have extra-territorial application beyond EU borders. This legislation will be directed at EU undertakings to ensure ESG alignment throughout the supply chain within the EU. The draft EU Resolution also means that undertakings operating outside of the EU that want to remain in business with EU undertakings will also need to comply with the EU Directive (once adopted) and adhere to these same ESG objectives.

In practical terms, this means that EU undertakings will in future be required to undertake due diligence investigations and publish results not only in relation to their own ESG compliance, but also in relation to the activities of other participants in their value chain, such as their suppliers. These investigations, among other things, will be required to focus on:

Environmental: the activities of suppliers in respect of their production of waste, diffuse pollution and greenhouse gas emissions, deforestation, and any other impact the suppliers may have on the climate, air, soil and water quality, the sustainable use of natural resources, biodiversity and ecosystems;

Social: whether such suppliers are adhering to appropriate standards applicable to the basic working conditions of their employees, whether these employees have the right to be unionized, whether suppliers make use of any child, forced or compulsory labour and other consideration concerning freedom of association, collective bargaining, minimum age, occupational safety and health and equal remuneration;

Governance: whether suppliers have anti-corruption and anti-money laundering measures in place that are implemented and whether the management of suppliers adhere to appropriate governance standards to facilitate transparency, access to information and accountability in respect of their business activities.

access to the internal EU market

The EU Resolution furthermore indicates that compliance by EU undertakings with these due diligence obligations in respect of their suppliers should be a condition for access to the internal EU market. This is likely to require suppliers and other operators (importers and freighting agents, for example) to establish and provide evidence, through the exercise of due diligence, that the products they place on the EU market are in conformity with the ESG criteria, set out in the future due diligence legislation that will regulate the scope and application of these investigations. Until that legislation matures, some guidance for agri-exporters to the EU is to be found in the OECD-Food & Agricultural Organization Guidance for Responsible Agricultural Supply Chains, which document is referred to in the EU Resolution.

The potentially far reaching effect of the proposed legislation is aptly illustrated by the definition of “supplier” in the EU Resolution, which means any undertaking that provides a product, part of a product, or service to another undertaking in the EU, either directly or indirectly, in the context of a business relationship. Similarly, the relevant “value chain” means all activities, operations, business relationships and investment chains of an EU undertaking. This includes entities that the undertaking has a direct or indirect business relationship with, upstream and downstream, and that either supply products, parts of products or services contributing to the EU undertaking’s own products or services, or, receive products or services from the EU undertaking.

EU Directives unpacked

Article 4.8 of the draft EU Directive stipulates that EU undertakings shall ensure that their business relationships put in place and carry out human rights, environmental and good governance policies that are in line with their due diligence strategy, including for instance, by means of framework agreements, contractual clauses, the adoption of codes of conduct or by means of certified and independent audits. EU undertakings shall ensure that their purchase policies do not cause or contribute to potential or actual adverse impacts on human rights, the environment or good governance.

Article 4.9 of the draft EU Directive provides that undertakings shall regularly verify that sub-contractors and suppliers comply with their obligations under Article 4.8. It is also anticipated that EU undertakings should set up an internal value chain mapping process that involves making proportionate and commensurate efforts in order to identify the business relationships throughout and in all stages of their value chain.

Article 5 of the draft EU Directive furthermore makes provision for a complaints or grievance process that may be initiated by any stakeholder, including persons whose rights and interests may be effected by any decision of an EU undertaking. The “stakeholder” concept includes workers, local communities, children, indigenous peoples, citizens, associations, shareholders and organisations whose statutory purpose is to ensure that human and social rights, climate, environmental and good governance standards are respected, such as trade unions and civil society organisations. These stakeholders are not confined to those present in the EU. This is in apparent recognition of recent international law developments where parent companies have been found to have incurred common law duties of care to foreign claimants as seen in the Dutch Court of Appeal where the parent company of the Shell Group was held to have incurred a duty of care to farmers in the Niger Delta (see too the UK Supreme Court decision of Lungowe v Vedanta Resources plc and Okpabi and others (Appellants) v Royal Dutch Shell Plc and another (Respondents).

Article 13.6 of the draft EU Directive stipulates that EU member states shall ensure that, if the failure to comply with the EU Directive could directly lead to irreparable harm, the adoption of interim measures by the EU undertaking concerned, or in compliance with the principals of proportionality, the temporary suspension of activities may be ordered. In the case of EU undertakings governed by the law of a non-member state that operate in the internal EU market, the temporary suspension of activities may imply a ban on importing into or operating in the EU internal market.

In summary, if the draft EU Directive is adopted in its current form, it is clear that compliance by EU undertakings with their due diligence obligations, including in respect of suppliers and operators outside of the EU, will be a condition for access to the internal EU market.

This is not the only proposed EU law that has potential implications for undertakings outside of the EU that export into the EU. On 14 July 2021, the EU Commission presented various policy measures and proposals aimed at reducing greenhouse gas emissions of EU member states and their business partners. The most contentious of these, from an international point of view, is the Carbon Border Adjustment Mechanism (CBAM), due to take effect in a transitional form from 1 January 2023 and be fully operational from 1 January 2026. It aims to avoid carbon tax leakage for certain product imports into the EU (such as aluminium, cement, iron and steel, electricity, and fertiliser) that are not subject to carbon tax in their country of production and which are manufactured using fossil fuels. The CBAM foresees an import levy on EU imports of these products, depending on the emission content of production and the difference between the EU Emissions Trading System price and any carbon price or tax paid in the country of production. It remains to be seen how this proposed EU mechanism will interface with South Africa’s existing carbon tax regime in terms of our Carbon Tax Act, 15 of 2019 and whether allowances or rebates will apply as a result of our domestic carbon tax. South African carbon taxpayers which reduce the South African carbon tax liabilities through permissible allowances and deductions may then pay a higher import carbon tax when their goods are imported into the EU.

While external motivators from the EU are likely to become a more present reality for South African businesses when it comes to ESG, internally South Africa’s National Treasury are driving their own ESG agenda and have already published the second draft of their green taxonomy. This document provides an indication of the technical and legal criteria that would need to be fulfilled on a sector by sector basis to be considered ESG aligned from a South African perspective. It will be interesting to see how potential future ESG requirements in the EU align with our own green taxonomy. One thing that is clear, supply chains will need considerable amounts of data to provide visibility across their global network. The sooner South African undertakings start on their ESG journey and set up platforms for data capture and reporting, the sooner they will be ready to adapt to both the locally and internationally developing ESG regimes.

James Brand

Natural Resources and Environment | Senior Associate

jbrand@ENSafrica.com

+27 79 877 7778

Koos Pretorius

Executive | Corporate Commercial

kpretorius@ENSafrica.com

+27 82 557 7927

Mansoor Parker

Executive | Tax

mparker@ENSafrica.com

+27 83 680 2074