In Practice Series – How to be an ESG-conscious product manufacturer
This article was originally published on Compliance & Risks 'In Practice Series' blog, September 2022.
Environmental, social and governance (ESG)-type obligations are increasingly imposed on actors in the modern product supply chain.
Such obligations impact all stages of the product lifecycle and additionally impose subject-matter specific reporting obligations on companies in respect of these matters.
The legal framework:
Some examples of existing and proposed mainstay obligations, using the EU as a reference point, include:
Supply chain due diligence
Legal framework: EU Timber Regulations 2010
Impact: Aimed at minimising the use of illegally harvested timber found in a wide range of products this legislation imposes obligations on various actors in the supply chain:
- Prohibiting placing on the EU market for the first time of illegally harvested timber and products derived from such timber.
- EU traders who place timber products on the EU market for the first time to exercise 'due diligence’.
- Recording keeping of suppliers and customers by economic operators.
Sourcing and material choice
Legal framework: Single-Use Plastics Directive 2019
Impact: The framework applies to the ten single-use plastic items most commonly found on Europe’s beaches, and is aimed at promoting sustainable alternatives. For single-use plastics outside this ambit, limiting the use of these products is ensured through a series of obligations.
Manufacture and design
Legal framework: Ecodesign Directive
Impact: This legal framework applies to energy-consuming products (covering over 40 product groups, including boilers, lightbulbs, and televisions) and imposes the following requirements:
- Minimum mandatory standards for energy efficiency.
- Technical standards for sustainability.
- Minimum energy efficiency standards.
Labelling and advertising
- Energy Labelling Regulation 2017
- EU Ecolabel (Regulation 66/2010)
Impact: The mandatory labelling regulation requires:
- Systems of energy labelling system on a scale from A to G for efficiency.
- Digital product database that makes it easier for regulators and consumers to check that the energy information is correct.
The voluntary ecolabel regime is awarded to products and services meeting high environmental standards throughout their life-cycle: from raw material extraction to production, distribution and disposal. The label allows consumers to recognise high quality eco-friendly products and encourages companies to develop products that are durable, easy to repair and recycle.
End of life and disposal of product
- Packaging and Packaging Waste Directive (PPWD)
- Waste Framework Directive (WFD)
- Directive on waste, electrical and electronic equipment 2012 (WEEE Directive)
Impact: The PPWD sets targets that Member States must meet by 2025 and renewed targets in 2030, as follows:
- Varying by material, up to 75% ability to recycle packaging.
- Encourages the use of reusable packaging and systems to ensure that the return, reuse or collection of used packaging or packaging waste is the most appropriate waste management practice.
- Producers will be obliged to finance, and at times organise, the return and/or collection of used packaging and/or packaging waste and ensure it is disposed of, reused or recycled appropriate.
The WFD presents a hierarchy for waste, including setting the order of preference for dealing with waste and delivering the best overall environmental outcome, as well as introducing the principles of the ‘polluter pays’ and ‘extended producer responsibility’. The hierarchy is based on: prevention; preparing for re-use; recycling; recovery; and disposal.
The WEE Directive aims to prevent creation of, re-use/recycle and improve the environmental performance of the EEE lifecycle to contribute to sustainable production and consumption.
Reporting obligations and ongoing due diligence
Legal framework: (Proposed) Directive on Corporate Sustainability and Due Diligence
Impact: Proposed to apply to companies (and their directors) with more than 500 employees and a net turnover of more than €150 million globally to require:
- Due diligence processes that are integrated into corporate strategy.
- Consideration of human rights, climate change, and environmental consequences in business decisions.
The regulatory trend
A snapshot from C2P showing the growth in ESG and sustainability related regulations across a number of key policy areas from 2014 to 2021. The rapidly increased acceleration of regulatory requirements and reporting obligations can be especially observed within the last two years, highlighting that ESG-type obligations are increasingly imposed on actors in the modern product supply chain.
There are range of potentially severe penalties that may arise as a result of non-compliance with the above regimes. The varied nature of these penalties is reflective of the broad-ranging involvement of different regulators, and different areas of law – which can range from product safety, to tax, to general corporate governance. Member States in the EU have their own discretion as to the scale and nature of these penalties which provides further chance for deviations. Just as damaging as formal sanctions, companies are also liable to suffer significant reputational harm to their brands.
Applicable monetary sanctions for breach of product safety regulations are often unlimited in many EU jurisdictions, or otherwise amount to a significant percentage of business turnover.
Criminal sanctions (incarceration)
Breach of product safety can result in terms of imprisonment, including in significant amounts of time in many jurisdictions.
Mandatory ADR/mediation processes
The proposed corporate due diligence process includes a requirement for mediation/ADR/other complaint mechanisms with complainants. This can result in business-critical delays of production or otherwise.
Victims of breaches of certain ESG-legislation, for example the proposed Due Diligence regime, will be entitled to compensation for damages if a company fails to comply with the mandatory requirements.
The impact of non-compliance with ESG-type obligations, particularly those around forced labour, are particularly difficult for a company to recover from.
Checklist to improve compliance
- Review product portfolio
Given the way ESG-obligations have arisen in this area, many companies are not fully aware of new obligations that may apply to their product portfolio. Companies should track and then review application of new legislation to their existing product portfolios.
- Be selective with supply chain
Although difficult to balance with competing lack of supply of relevant products in some areas, companies should require any new partner to complete thorough and comprehensive onboarding and include protective contractual clauses within any supply agreements to ensure ESG obligations imposed on companies are requirements suppliers need to adhere to also.
Regular and thorough review processes should be implemented to monitor supply chain compliance with these obligations. Companies could consider requiring declarations from supply chain throughout the lifetime of their supply.
- Consider alternative materials and production mechanisms
Scrutiny is likely to be imposed on certain materials, such as plastics and single-use items. Companies should consider whether they are able to find long-term alternatives to reduce use of these highly taxed and regulated products. Similarly, reduction of use of natural resources during production should be considered. Companies should ensure the integrity, safety and standard of their products are not compromised by these changes, and the new product is fully compliant with applicable product safety standards.
- Be diligent with record making and keeping
Companies should consider in advance their mechanisms for tracing and recording their consideration of ESG-obligations to assist in establishing due diligence and complying with reporting requirements. Streamlined and formalised report forms should be made. Systems to flag growing concerns should also be implemented. Ideally a separate and dedicated business unit should be created for compliance with ESG obligations. Such systems should ensure they capture all relevant information that is covered by the legal frameworks.