Deconstructing EHS Supply Chain Management

Authors: George Zhu, Carey Ni

Summer Sun and Tina Yang

ESG Special Topic Series (XII) - Deconstructing ESG Supply Chain Management

Background

In recent years, the Coronavirus (COVID-19) pandemic has brought many new challenges and uncertainties to global supply chains. To deal with such challenges, some companies have increased their number of suppliers, while others have further developed their upstream and downstream capabilities to protect their supply chains. Supply chain management is an important dimension of Environmental, Social and Governance (“ESG”) risk management. This article intends to help companies understand some of the key issues involved in ESG supply chain management. It provides information regarding ESG disclosure standards and some of the legislative trends of ESG supply chain management in various overseas countries.

I

What is ESG Supply Chain Management?

1

// Global Level

According to the Consolidated Set of the Global Reporting Initiative Sustainability Reporting Standards (“GRI Standards”), we understand that a supply chain refers to sequence of activities or parties that provide products or services to an organization. A “product” refers to an article or substance that is offered for sale or is part of a service delivered by an organization; a “service” refers to the action of an organization to meet a demand or need.

2

// Domestic Level

China has introduced many laws, regulations and recommended standards regarding supply chains, which define the meaning of “supply chains” or “green supply chains.” These include the Guiding Opinions of the General Office of the State Council on Actively Promoting Supply Chain Innovation and Application (the “Guiding Opinion”), and the Supply Chain Risk Management Guideline (GB/T 24420—2009), Supply Chain Management (GB/T 26337), and Green Manufacturing—Green Supply Chain Management in Manufacturing Enterprises-Guideline (GB/T 33635-2017) (the “Green Supply Chain Management Standard in Manufacturing Enterprises”), an enterprise evaluation index system of green supply chain management in the machinery, automobile and electronics industries. According to the Guiding Opinion, a “supply chain” refers to an organizational form of efficient coordination during the process of a product’s design, procurement, production, and sales and service with the goal being quality improvement and efficiency by means of resource integration. The Green Supply Chain Management Standard in Manufacturing Enterprises defines a “green supply chain” as having a goal of environmental protection and resource saving， which exists through the entire process from product design to raw material procurement, production, transportation, storage, sales, usage and disposal and ensures a company’s economic activities in harmony with the environment protection goals of the upstream and downstream supply relationship. The definition of a “green supply chain” that empowers the environmental (E) elements is therefore based on the definition of a “supply chain.”

Based on the above analysis, the concept of ESG supply chain management could be understood as the entire process and activities of a company’s comprehensive planning, organizing, coordinating and controlling, which involves the flow of business, logistics, cash and information with the help of technology, to practice an ESG strategy, in order to unify the economic value, environmental justice and the public welfare of a company.

II

Why is ESG Supply Chain Management important?

1

// Voluntary Standards

From a global perspective, GRI specifies the disclosure requirements on supply chain management in the GRI Standards, i.e., the status of a company’s supply chain (including the type, number, location, currency valuation, major brands, products and services, labor intensity, of the signing suppliers, any major changes and the impact of such changes, etc.) should be disclosed during the reporting period. The China Enterprise Reform and Development Society released the Guidelines on Corporate ESG Disclosure. The guidelines take supply chain management as an independent disclosure index under social indicators and set out the qualitive or quantitative disclosure requirements. Meanwhile, there are other compliance management requirements for suppliers under environmental protection and corporate governance indicators.

2

// Mandatory Standards

From a global perspective, some countries or economic and political communities like the European Union (“EU”), Germany, the United Kingdom and the United States have released regulations to supervise ESG supply chain management. For instance, in June 2021, the Federal German Parliament passed the Supply Chain Due Diligence Act, requiring German companies analyze and report the relevant compliance matters of entities involved in their supply chains (including Chinese suppliers) in connection with environmental protection, human rights and other aspects. This will come into effect on January 1, 2023. On February 23, 2022, the EU Commission released a proposal for the Directive of the European parliament and of the council on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937. The proposal imposes due diligence obligations in connection with environmental and human rights protection on the following EU and non-EU companies involved in supply chain management: (a) EU companies (i) with over 500 employees and a net turnover of more than EUR 150 million, or (ii) with over 250 employees and a net turnover of more than EUR 40 million, provided that at least 50% of the turnover is generated in the EU; and (b) non-EU companies (i) with a net turnover of more than EUR 150 million, or (ii) with a net turnover of more than EUR 40 million, provided that all of the turnover is generated in the EU. In addition, the EU Commission published the Directive 94/62/EC of 20 December 1994 on packaging and packaging waste and other directives and regulations to set out the specific requirements for supply chain management in connection with packaging.

From a domestic perspective, China has released certain laws and regulations involving environment, health and safety (“EHS”) on supply chain management, indicating that the compliance management of suppliers is becoming increasingly important for companies to prevent compliance risk. In some cases, a company that fails to conduct thorough due diligence on its suppliers may face civil liability, administrative penalties or even criminal punishments. Therefore, it is now common for companies to conduct regular EHS compliance and EHS supplier audits.

Disclosure rules for listed companies are emphasizing the increasing importance of ESG disclosure. The Guidelines for Investment Relationship Management for Listed Companies became effective on May 15, 2022, and provides that listed companies shall disclose a company’s ESG information during the management of the investment relationship. There are no further details available on how to disclose such information, but we believe that information related to supply chain management should also fall within the scope of ESG disclosure.

III

How should companies deal with ESG Supply Chain Management?

The ESG supply chain management of an enterprise can only be achieved with the cooperation of multiple departments such as procurement, legal, risk control, public relations and finance. We recommend that enterprises strengthen the management of their supply chains by taking the following measures:

1. Enterprises should establish, improve and operate their own ESG supply chain management systems, and implement systems for the selection, training, assessment, supervision and elimination of suppliers, as well as supplier specific ESG management policies. In particular, the ESG supply chain management systems of export enterprises should be established based on the full identification of the regulations and local practices of the countries and regions where their customers are located. It should be noted that multinational corporations should fully understand and apply their ESG supply chain management systems, to meet the domestic and foreign compliance requirements regarding ESG supply chain management.

2. Enterprises should strive to include ESG related representations and warranties in their supply chain related commercial contracts. They should explicitly require their suppliers to comply with (i) the international standards and domestic regulatory requirements that they commit to and that they expect their suppliers to comply with, (ii) their policies regarding the ESG management of suppliers, and (iii) appropriate reporting mechanisms when ESG problems arise, to strengthen contractual constraints.

3. Enterprises should regularly organize internal and external auditors to conduct supply chain ESG or EHS compliance reviews, especially for suppliers of critical raw materials. Auditors can help enterprises establish and/or upgrade their ESG supply chain management systems, identify ESG risk points, and urge suppliers to track and solve problems in a timely manner.

The ESG management of supply chains plays a vital role in the ESG risk management of enterprises and affects their sustainable development capacity. Alongside our traditional long-term legal and compliance services, we can perform legal due diligence into customized ESG compliance reviews and incorporate ESG factors and considerations when drafting and reviewing commercial contracts. We are able to assist our valued clients in all areas of ESG compliance.

We can assist you to establish or improve your company's or your supplier's ESG management systems. We can also draft relevant rules and policies, assist with your ESG and EHS due diligence, draft and review supply chain-related commercial contracts, and provide ESG training and other services. Please contact us by email for further information: ecoenvpro@junhe.com

The JunHe EHS and ESG Team: JunHe, with over 970 professionals, is one of China’s largest full-service law firms with an international reputation in providing high quality legal services. As one of the pioneers in the practice area of ESG in China and one of the largest teams of environment, health and safety (EHS) lawyers in the country, JunHe provides clients with a full range of EHS and ESG legal services. Our team is sustainability-oriented and provides EHS compliance audit services for enterprises with different industrial backgrounds depending on the specific needs of the clients, either alone or in collaboration with third-party agencies. JunHe relies on different legal and professional compliance teams (including ESG, EHS, antitrust, labor and employment, intellectual property, trade and data, finance and tax, business, criminal compliance and other professional teams related to ESG areas) to provide ESG due diligence services in supply chain management and M&A matters and cooperates with enterprises and third-party agencies to draft ESG reports. Based on our experience in serving clients from different industrial backgrounds, we can provide a package of specialized services for the daily operations of enterprises, including specialized ESG-related legal and compliance diagnosis, as well as drafting and reviewing ESG-related terms and clauses in contracts with business partners, the construction and enhancement of ESG systems, the identification of ESG disclosure requirements, green finance, and ESG training.

George Zhu

zhuh@junhe.com

Practice Area

Corporate and M&A

Infrastructure and Project Finance

Environmental, Health and Safety Compliance

Environmental, Social and Governance

Carey Ni

Partner

nitl@junhe.com

Practice Area

Environmental, Health and Safety Compliance

Environmental, Social and Governance

Corporate and M&A

Summer Sun

sunjp@junhe.com

Tina Yang

Associate

yangyt@junhe.com

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