The German Supply Chain Due Diligence Act (LkSG) – Review and Future Strategies

The German Supply Chain Due Diligence Act (LkSG) has successfully completed its first year of implementation and represents an important and correct step towards promoting sustainable supply chains and thus responsible corporate governance in Germany. In line with the EU’s Green Deal, which aims to make sustainable corporate governance the European standard, the law requires companies to apply comparable environmental and social standards in their supply chains. The first wave of the LkSG which came into force on 1 January 2023 and initially only affected companies with more than 3,000 employees and a location in Germany, requires companies to fulfil their due diligence obligations, i.e. to identify human rights and environmental risks, counteract them and document these efforts. One year after the law came into force, we want to assess the progress made, reflect on the successes and challenges, and look ahead to the future of the companies concerned.

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Encouraging results

During the 2023 inspections, the Federal Office of Economics and Export Control (BAFA), as the supervisory authority, focused primarily on risk management and the complaints procedure prescribed for companies. It is noteworthy that most companies have defined internal responsibilities and created new positions, thus laying a solid foundation for fulfilling further due diligence obligations.

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A recent survey of 2,000 companies in Germany by the Handelsblatt Research Institute (HRI) on behalf of Creditreform¹ found that the vast majority of companies already pay attention to compliance with human rights and environmental standards in their supply chain or, in some cases, take appropriate measures. According to BAFA² , in 2023 a total of 486 inspections were carried out at affected companies, most of them in the automotive, chemical, pharmaceutical, mechanical engineering, energy, furniture, textile and food and beverage industries. 78 inspections were carried out independently of the sector, because BAFA saw possible breaches of obligations or because of changes in the supply chain.

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There were also 38 complaints, including from Oxfam, which led BAFA to contact companies in six cases. On a positive note, the companies have responded proactively to the complaints, demonstrating in particular their willingness and commitment to address the issues. No sanctions have been imposed so far, which indicates a general compliance with the newly introduced regulations.

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Stages and achievements

Since August 2022, several ‘handouts’ published by BAFA to provide guidance to affected companies in Germany have brought more clarity to the complex list of obligations under the Supply Chain Act. These provide detailed information on the due diligence obligations that companies must fulfil in order to comply with the Supply Chain Act. The requirements for comprehensive risk assessments, risk mitigation measures, monitoring systems and transparent reporting set out in these handouts have been instrumental in providing companies with a clear framework to navigate the complex legislation and understand their obligations.

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A notable milestone is the increasing awareness and commitment of companies to responsible practices in the supply chain. This is reflected in the integration of sustainability criteria into supplier selection, regular audits and the active promotion of transparency. While many companies have yet to take effective action, the law has been instrumental in making some companies more accountable for fulfilling their due diligence obligations. The results of a joint study by the Pakistani trade unions NTUF and HBWWF and the German human rights organisations FEMNET and ECCHR³ show that “companies are seriously trying to investigate labour rights violations and take effective action to remedy them”. This was often not the case in the past and shows that the LkSG is already having a positive impact. In order to comply with the principles of the law, companies must strive to fully integrate fair practices throughout their supply chain.

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Difficulties and challenges

Despite progress, challenges remain. One of the biggest difficulties companies face is the complexity of their supply chains. Supply chains can be very complex, involving multiple layers of suppliers and sub-suppliers, making it difficult to track and monitor every step of the production process. As a result, companies often find it difficult to obtain accurate and reliable information from their suppliers about their practices and compliance with human rights and environmental laws.

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Another challenge is the lack of standardised reporting and verification mechanisms, which makes it difficult for companies to accurately assess the social and environmental impacts of their supply chains. Companies therefore rely on self-reporting and voluntary audits, which can vary in intensity and reliability.  

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The implementation of the LkSG has also highlighted the importance of collaboration and communication between companies and their supply chain partners. Effective communication and collaboration are critical to sharing information, solving problems and implementing responsible and sustainable practices.

In addition, employee development and training play a critical role for compliance with the LkSG. Companies should also invest in training their suppliers and subcontractors so that they understand the requirements of the LkSG and know how to comply effectively. This includes training on human rights and environmental regulations, as well as guidance on implementing sustainable processes and responsible sourcing. According to the HRI survey, around 30 per cent of companies need a full-time position dedicated to the law. The same number of companies say they need up to three full-time positions. Almost 17 per cent of companies require up to six full-time positions, and around ten per cent even more. The problem is that for SMEs, the costs are significantly higher in relation to their number of employees and turnover. Unlike large companies, which can meet their obligations with comparatively little effort, SMEs are at a disadvantage. The BAFA annual report also shows that some companies have attempted to pass on their obligations under the LkSG to their SME suppliers through contractual assurances. However, such a blanket transfer of obligations under the LkSG to suppliers is not permitted.

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Digitalisation and automation

In addressing the challenges of the LkSG, several good practices have emerged for companies. First, companies have found that implementing a software tool designed specifically for supply chain management and traceability can significantly improve their ability to effectively monitor and manage their supply chains. These tools offer features such as real-time tracking of products, traceability of materials and components, and automated data collection for reporting purposes. By using a software tool, companies can improve their supply chain management and ensure compliance with regulations such as the LkSG.

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The second lesson was the value of conducting regular supplier audits and assessments.These audits make it possible to assess suppliers’ compliance with human rights and environmental regulations, identify areas for improvement and take corrective action where necessary. Companies have also recognised the importance of establishing clear and transparent channels of communication with their supply chain partners. Through regular communication, companies can foster a spirit of cooperation and trust, ensuring that all parties are on the same page when it comes to responsible practices.  Applying these best practices will not only ensure compliance with the requirements of the LkSG, but will also enable companies to prepare for the forthcoming, even more comprehensive European supply chain legislation, the Corporate Sustainability Due Diligence Directive(CSDDD).

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Planning ahead for compliance

From 1 January 2024, the second wave of the LkSG came into force in Germany, requiring companies with more than 1,000 employees to comply with the requirements of the LkSG. For companies with more than 3,000 employees, BAFA audits will continue to focus on risk analysis. This year, BAFA has stated that it will continue to focus on a collaborative approach to ensure that companies work with their suppliers to understand and improve the human rights situation in their supply chains.

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The implementation of the LkSG has shown companies that proactive planning is essential. Thorough assessment of supply chains, identification of potential risks and vulnerabilities, and development of appropriate strategies are key.Companies that responded proactively to these requirements of the LkSG and took timely action to comply were better able to meet the challenges and obligations. Companies that had already invested in sustainable supply chain management prior to the introduction of the Act were able to adapt more smoothly and efficiently to the new requirements.

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One way to efficiently plan ahead is to use a digital supply chain management solution to create transparency and traceability. A key challenge in implementing the LkSG in 2023 is that companies need to create more visibility and transparency in their supply chains. Software solutions offer clear advantages here, providing a central platform to track and monitor every process in the supply chain, from raw material procurement to delivery of the final product. This transparency enables companies to identify and address potential ethical and environmental issues and ensure compliance with the LkSG.

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In addition, companies can use software solutions to collect and analyse data about their suppliers, such as audits, certifications and performance indicators. This data-driven approach not only helps companies assess their suppliers’ compliance with ethical and sustainability standards, but also enables them to make informed decisions about supplier selection and collaboration.  With the right supply chain management software, companies can also proactively manage risk and identify potential violations in their supply chains. In this context, osapiens has already successfully supported companies worldwide in complying with the LkSG and ensuring legal certainty.

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The osapiens HUB for Due Diligence is a software, specifically designed to meet the requirements of the German and European Supply Chain Due Diligence Act (LkSG/CSDDD) in a seamless, digital, automated and legally compliant manner. Discover how our solutions ensure fast, secure and digital implementation of all your company’s due diligence obligations, as well as other areas of application within the numerous ESG regulations, such as the Corporate Sustainability Reporting Directive (CSRD), to improve your company’s compliance.

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Sources:

¹ „Große Mehrheit für Lieferkettengesetz“. Handelsblatt, www.handelsblatt.com/unternehmen/mittelstand/lieferkette-grosse-mehrheit-fuer-lieferkettengesetz/100002172.html.

² “Ein Jahr Lieferkettengesetz: BAFA zieht positive Bilanz.” Bundesamt für Wirtschaft und Ausfuhrkontrolle (BAFA), https://www.bafa.de/SharedDocs/Pressemitteilungen/DE/Lieferketten/2023_21_1_jahr_lksg_-_bafa_zieht_positive_bilanz.html#:~:text=Januar%202023%20m%C3%BCssen%20Unternehmen%20mit,Unternehmen%2C%20ohne%20sie%20zu%20%C3%BCberfordern.

³ „Lieferkettengesetz zeigt Wirkung: Modemarken reagieren auf Hinweise zu Arbeitsrechtsverletzungen“. European Center for Constitutional and Human Rights (ECCHR), www.ecchr.eu/pressemitteilung/ein-jahr-lieferkettengesetz-vortragsreise-zu-arbeitsbedingungen-in-pakistan.

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