The Supply Chain Due Diligence Act (Lieferkettensorgfaltspflichtengesetz - LkSG) has been in force in Germany since January 2023, obliging companies to identify and remedy human rights and environmental risks in their supply chains. The European Union is now moving ahead with its own Corporate Sustainability Due Diligence Directive, which will require amendments to the LkSG, having to be transposed into national law by 2026.

The LkSG has its roots in the Rana Plaza disaster. In April 2013, a factory complex collapsed in Dhaka, killing over 1,000 people. The clothing produced in this complex was mainly destined for export and was sold by fashion brands such as Primark and Benetton. This tragic event led to a rethink, and exposed the catastrophic working conditions in textile production. The disaster showed that voluntary agreements were not enough. This led to calls for binding regulations. In Germany, this ultimately led to the LkSG.

The LkSG covers 1. risk management. This means that companies must regularly identify and assess risks in their supply chain. 2. remedial measures: If violations are discovered, immediate action must be taken to eliminate them. 3. reporting: companies must publish annual reports on their due diligence processes, which are reviewed by the competent authority, the Federal Office for Export Control (BAFA).

Companies that fail to take preventive or remedial measures, or fail to do so in good time, are committing an offence and risk fines. A growing flood of unfiltered and diverse information on possible violations of human or environmental rights in foreign supply chains is now landing on the desks of German companies via the complaints channel opened under the LkSG, says Julia Kahlenberg at Pohlmann & Company.

BAFA plays a central role in monitoring compliance with the LkSG. It carries out risk-based inspections and reviews reports submitted by companies. Between January 2023 and July 2024, BAFA carried out over 1,200 inspections and received 638 reports. Despite the large number of inspections and reports, no sanctions have been imposed to date.

Small and medium-sized enterprises (SMEs), in particular, face considerable challenges as a result of the LkSG. The results of a survey conducted by the Düsseldorf Chamber of Industry and Commerce in July 2024 show that many companies perceive the bureaucratic effort and cost burden as a high burden. A fundamental problem is the complexity of supply chains. Especially for companies with many suppliers and their sub-suppliers – often in different countries – it isn't easy to ensure the transparency required by the LkSG. Only 30% of large companies stated that they were aware of the working conditions at all of their direct suppliers. The figure was even lower for smaller companies.

Despite the criticism, companies also see opportunities in the Supply Chain Act. Improving their reputation and ensuring long-term sustainability in the supply chain are positive aspects that larger companies in particular emphasise. Many hope that compliance with the legal requirements will enable more transparent and effective supplier management. However, the survey results also show that smaller companies, in particular, are sceptical about the benefits of the law. 35% of the SMEs surveyed stated that they did not expect any benefits.

Compliance advisory company Pohlmann sees the LkSG as both a challenge, and an opportunity for improvement. „A thorough investigation is not only a legal obligation but also a strategic opportunity to achieve long-term sustainability goals in the supply chain," says Kahlenberg. “However, the growing number of reports of possible human rights or environmental violations presents companies with significant challenges." Companies must weigh up whether to carry out these investigations themselves or delegate them to independent third parties“.

Uwe Erling, also a partner at Pohlmann, emphasises that it is also possible for „the supplier to investigate the allegation themselves as far as possible“ but to be monitored by an independent third party. This approach could be a practicable solution for many companies, as it allows them to ensure compliance with legal obligations without placing too significant a burden on their resources.

Another key result of the IHK survey concerns the internationalisation of companies. Large companies, in particular, have a solid international presence: Almost all of these companies have sites in the eurozone, three quarters are represented in North America, and half have branches in China or the UK. Among smaller companies, 60% also have international locations. This presents companies with challenges when it comes to monitoring their supply chains.

A look at the procurement markets shows that both large and small companies are heavily dependent on international suppliers. Around a third of large companies are examining whether they should withdraw from problematic markets, which was triggered by the LkSG.

The LkSG is a pioneer in European supply chain regulation. On 24 April 2024, the European Parliament approved a Directive which is to be implemented in 2026. This directive provides for similar obligations to the German law but covers a smaller number of companies. However, it imposes stricter obligations on the companies concerned.

The role of independent third parties, who are to verify compliance with due diligence obligations under the EU directive, will become significantly more critical. These external auditors are to ensure that companies and their suppliers adhere to the agreed codes of conduct and take action if violations are identified. This verification by independent third parties has so far been less well developed in Germany.

The Supply Chain Due Diligence Act has triggered a debate about the responsibility of companies in global supply chains. While the law undoubtedly makes an essential contribution to the protection of human rights and the environment, many companies – especially SMEs – are faced with considerable challenges. The bureaucratic hurdles and the associated personnel costs are a burden for many. It remains to be seen to what extent the LkSG and the EU Directive will help to make supply chains fairer. However, companies will be held more accountable.