Australia’s largest corporations are coming under increasing pressure to scrutinise their international supply chains for human rights abuses and environmental damage, as a result of laws just introduced in the European Union.

The EU Corporate Sustainability Due Diligence Directive, which came into force last month, requires large companies to identify and address a range of infringements in their global operations and supplier networks. Issues covered include working conditions, wages, housing, discrimination and pollution. Companies covered by the directive must introduce mechanisms for complaints and compensation, and noncompliance can lead to significant financial penalties.

The new EU directive has extraterritorial applicability. It could apply, for example, to an Australian company that sells manufactured goods in the European market, or that provides raw materials in any part of a European company’s supply chain.

The message is: Australia needs to keep its corporate environmental, social and governance (ESG) standards in line with major trading partners such as the EU. As a first step, the federal government is urged to amend Australia’s Modern Slavery Act to include mandatory action provisions, as recommended by a major review of the act conducted more than a year ago.

Environmental obligations under the directive will also complement recently introduced EU regulations that are already posing challenges to Australian exporters. One example is new deforestation rules that are impacting Australia’s beef industry. They require “certain raw commodities to be geolocated … to ensure they aren’t being produced at the risk of deforestation in certain areas,” says Phoebe Wynn-Pope, the head of responsible business and ESG at law firm Corrs Chambers Westgarth.

Australia’s mining and extractive sectors could be particularly exposed to the EU directive on environmental grounds, says Jason Collins, chief executive of the European Australian Business Council (EABC). So too, he says, could any Australian companies “operating in jurisdictions where there are issues around labour and standards”. Those may include companies linked to manufacturing of batteries, solar panels, timber, some textiles and agricultural products.

From next year at the earliest, some of Australia’s largest companies could be subjected to mandatory climate-related financial reporting – an already delayed reform under the federal government’s Sustainable Finance Strategy.

The EU due diligence directive could leave some Australian companies facing a “compliance nightmare” in overseas markets, says Collins.

“It is very difficult for companies to identify, confirm and certify that they have no instances of bad practices within the global supply chain,” he says.

Australian environmental sustainability laws do not go as far as the EU directive, says Dr Nga Pham, a senior research fellow at the Monash Centre for Financial Studies. “We don’t have very strong environmental legislation in this area. The [directive] specifically requires companies to have a climate transition plan and to disclose that plan. On the environmental side, we have lots to catch up on.”

The EABC’s Collins says Australian companies are concerned about a lack of clarity on how the directive will be implemented. He’s calling on the federal government to bring domestic sustainability regulations into line with one of the world’s largest trading blocs.

“It would be a perverse outcome to have robust ESG reporting obligations in Australia that were inoperable with European ones: processes would have to be duplicated or we’d end up in a kind of confused nightmare.”

The EU due diligence obligations will be phased in over five years from 2027, after they are incorporated into the national laws of member states. Ultimately, it will apply to companies with a turnover within and outside the EU of €450 million, or more than $750 million.

“The impacts will be quite big because of the extent and reach of the directive,” says Phoebe Wynn-Pope. She says its impact “will trickle down in supply chains”, and overseas parent companies could also use contractual arrangements to share the cost of fines or other penalties with Australian subsidiaries or suppliers.

Other than meeting employee and revenue requirements in the EU, Wynn-Pope says an Australian company could be directly affected by a parent company “pushing down” as it is required to implement the directive through its entire operation, by selling goods and services into Europe, or by having European business partners.

“You’re buying cotton from Goondiwindi that’s going to a factory in Malaysia and on to Europe, or you’re the company providing the cotton. The company making the clothes is European or impacted by the directive and wants to know where your cotton comes from – a company in Goondiwindi may be required to provide verification under a contractual arrangement,” Wynn-Pope says.

It is not yet clear how potential disruptions to supply chains in Asia in response to the European directive’s compliance obligations could affect Australian exporters or companies with ties to the region. But Wynn-Pope says Australian companies should be looking more closely at their ESG obligations.

“A lot of our market is in Asia. And some of the biggest challenges are in Asia.”

Progress has been made among Australian corporations in eliminating ties to sweatshops and other workplace abuses from their supply chains. In a submission to a review of the Modern Slavery Act that was introduced in 2018, the Business Council of Australia says Australian businesses – among them Wesfarmers, Rio Tinto, BHP and Woodside Energy – have been working to develop approaches to address modern slavery risks and provide solutions when instances occur in overseas supply chains.

That is reflected in mandatory reporting under the act, says Nga Pham from the Monash Centre for Financial Studies, which does an annual assessment of the quality of modern slavery disclosure compliance by ASX 100 companies. In its most recent report, for the 2022 financial year, the centre found Woolworths, BlueScope Steel, Fortescue and Rio Tinto were among more than 40 companies to receive the highest – A-grade – ranking. Overall, Pham says, there’s been notable improvement in three years of mandatory supply chain reporting. But, she says, companies still aren’t making the link between exposure to risks and their responsibility to address them.

“If we compare ourselves to Europe, Australia is definitely lagging behind. That’s why in many areas of ESG you see investors pushing for more changes, stricter regulations … Because they have seen it in the European markets,” says Pham.

“There is no doubt what Europe is proposing will add pressure on Australian businesses and the Australian government to be serious about due diligence,” says Professor John McMillan, who presided over the Modern Slavery Act review.

The most significant recommendation of the 30 in his report from May last year is a legislated requirement for mandatory due diligence action, with civil penalties for noncompliance.

The only action taken by the government in response so far is a commitment to appoint an Anti-Slavery Commissioner.

“It’s notable that the government has had the report for 14, 15 months and they haven’t formally responded … A formal response would demonstrate the government’s sincere commitment to modern slavery reform,” says McMillan.

“If you’re going to get legislative change … you’re looking at two to three years down the track before that happens. The process is moving slowly.”

“There is an opportunity for Australia to keep its international reputation strong through firm commitment to the modern slavery reporting process.”

Human rights groups also lament the delay in the government’s formal response to the review of the act.

“There is frustration not just from civil society – businesses are also looking for certainty in this area and are waiting to understand if the act will be strengthened,” says Lauren Zanetti, a senior lawyer in the Human Rights Law Centre’s corporate accountability team, who also sits on the federal government’s Modern Slavery Expert Advisory Group.

“Transparency-based reporting legislation hasn’t been shown to be sufficient to drive meaningful changes for vulnerable workers in our global supply chains … Fundamental changes are needed to the legislation.”

Zanetti says Australia should follow
the EU’s lead and introduce similar due diligence laws.

In a statement to The Saturday Paper, a spokesperson for Attorney-General Mark Dreyfus says: “Tackling the scourge of modern slavery is a priority for the Albanese Labor Government. That’s why we established the office of Australia’s first Anti-Slavery Commissioner earlier this year … The government is currently considering the detailed recommendations made by Professor McMillan … and will respond shortly.”