The importance of ESG in business has become clearer as the moral and ecological reasons are now obvious to everyone. In theory, all companies support the idea of doing business in a more sustainable and climate-friendly way. However, in practice, companies usually only do something when they have to. In Hungary, there isn’t any binding ESG supply chain act in place yet, which could wrongly lead to the conclusion that the topic is unimportant. Yet considerations about ESG in the supply chain are no longer nice-to-have but have become a must-have globally, and Hungary is no exception. There are various locally relevant reasons for which companies must start prioritizing the management of ESG risks in their supply chain.
As an example, failing to meet ESG criteria at the manufacturing site by using unacceptable working conditions puts the whole company at high exposure for reputational and other risks. This is relevant to all suppliers in the chain, particularly given that, according to recent studies, approximately two-thirds of the average company’s ESG footprint is generated by its suppliers. For a number of international companies, Hungary is the seat of either their direct or indirect supplier, whilst for several investors also the seat of their own production facility. Hungarian companies cover each part of the ESG puzzle and neither of these entities can afford to exclude the wider ESG picture any longer.
There have been a few examples recently that highlight the importance of ESG across all elements of the supply chain. A scandal related to the horrible working conditions at a luxury brand owner’s facility in India surfaced, and the company suffered serious damage to its brand, although the company itself did not breach any laws. Similarly, a tech giant attracted close scrutiny when many suicides were recorded at one of its Chinese factories. Subsequent investigations uncovered mandatory overtime, overcrowding, etc. The aftermath of the findings wiped almost USD 30 billion off the company’s value in a single day.
All these cases highlight that not managing ESG risks throughout the supply chain can cause major financial and reputational losses, even if the company itself does not breach any laws. In case of a similar scandal, not breaching any Hungarian law wouldn’t save the Hungarian company from the indirect losses of the company group. Dealing with supply chain risks in advance can help minimize environmental and social impacts while protecting the company’s brand. All the companies in the examples above have since introduced robust supply chain sustainability programs, which are now mandatory for all of their suppliers.
Further pressure on ESG considerations comes from regulators and other stakeholders. ESG issues are at the center of both business and political agendas globally. Investors, business partners, the media, and consumers urge companies to conduct their businesses in a way that cares more about ESG issues. The above examples also show that these goals cannot be achieved if we look at the company as a standalone entity. Hungarian companies – wherever they stand in the supply chain – must look closely at their value chains to foster sustainable and responsible corporate behavior, by monitoring their every aspect and taking appropriate actions to meet ESG requirements.
Nevertheless, the legal framework for global supply chains continues to evolve. Soft law regulations are now being converted into hard law provisions. An example is the German Supply Chain Act, whose effects may extend to businesses headquartered outside Germany, such as to their Hungarian affiliates. At the EU level, the Proposal for the Corporate Sustainability Reporting Directive would introduce detailed reporting requirements, confirming the crucial role of value chains in measuring a company’s carbon emissions and its complete environmental and product footprint. The Proposal for the Corporate Sustainability Due Diligence Directive would impose a due diligence obligation on companies to identify actual and potential adverse impacts on human rights and the environment, including regarding the company’s value chain operations carried out by their established business relationships.
The reporting and DD obligations will be burdensome for Hungarian companies as well, and it is advisable to start preparations with plenty of time to spare. The implementation of extended risk analysis tools, preventive measures, and remedies against human rights and environmental violations in the supply chain is not only recommended, to prepare for upcoming laws, but is also required for the non-regulatory related reasons mentioned above.
Veronika Kovacs, Senior Counsel and Head of CEE Public Procurement, CMS
This Article was originally published in Issue 9.7 of the CEE Legal Matters Magazine. If you would like to receive a hard copy of the magazine, you can subscribe here.
