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Cutting deforestation out of supply chains:

new due diligence regulation to decrease EU contribution to global deforestation enters into force

At a glance

 

  • On 29 June a landmark due diligence regulation entered into force that prohibits the sale or export of certain products on or from the EU market unless it can be proven they are “deforestation-free”. Companies will now have between 18-24 months to implement the new rules. Companies could face fines of up to 4% of their turnover in the EU for non-compliance with the regulation, in addition to other penalties such as confiscation of products.
  • The EU Regulation on deforestation-free supply chains will have a wide reach primarily in the consumer industry, affecting any company that sells or exports the relevant commodities and products to or from the EU market. Its principal burden will be on companies that are making relevant products available on the market for the first time, or exporting them.
  • Initially the regulation will not apply directly to financial institutions, but this will be reviewed by the European Commission in two years.
  • Affected companies should begin implementation planning to determine which of their supply chains are affected, and to understand what aspects of the due diligence statement they will need to comply with.
  • This article is relevant for CSOs, COOs, General Counsel and heads of supply chain.

Aim of the regulation and its requirements

Between 1990-2020 an area larger than the EU was lost to deforestation globally, with EU consumption estimated to have caused 10% of these losses. Voluntary progress on reducing deforestation in supply chains has been slow: for example, a recent report by Forest 500 found that 40% of the companies and financial institutions with the most exposure to and influence on tropical deforestation still have not set a policy on deforestation. This new EU regulation on deforestation-free supply chains aims to address this by increasing EU demand for deforestation-free products and closing existing loopholes regarding legal deforestation. It does so by prohibiting the sale in or export from the EU market of cattle, cocoa, coffee, palm oil, soya, wood, or rubber (or certain products made or fed with these commodities such as leather or chocolate, or products made with livestock that have been fed with soy) unless they are accompanied by a due diligence statement confirming that the products are deforestation-free and have been produced in compliance with the relevant legislation of the country of production. Used commodities and products that have completed their lifecycle and would otherwise be treated as waste are excluded from the scope of the regulation.

  • Deforestation-free” means that the land has been free from deforestation and forest degradation since 31 December 2020: this includes conversion to agricultural use, or conversion of primary forests or naturally regenerating forests into plantation forests or planted forests. The definition of deforestation-free that has been adopted by the EU is widely considered ground-breaking: it is much broader than the current prohibition it replaces against illegal logging under the EU Forest Law Enforcement Governance and Trade Regulation, because it also captures legal deforestation. This is also a key difference from the proposed FOREST Act in the United States, which only would restrict commodities produced on illegally deforested land.
  • Relevant legislation of the country of production” includes land use rights; environmental protection; labour rights; tax, anti-corruption, trade and customs regulations; and importantly, international human rights and the principle of free, prior and informed consent (FPIC) of indigenous peoples. The practical implementation of this requirement is currently unclear: for example, it appears that if international human rights principles or FPIC are not applicable in the domestic law of the country of a product, then companies will not be required to show a product is compliant with it as part of the informational requirements of due diligence. However, this absence of legal protection may cause the Commission to assign the product a higher risk rating, and is a required consideration as part of the risk assessment aspect of due diligence.

The regulation expressly provides for the prohibition to be extended to other ecosystems and other commodities. The Commission will evaluate in one year whether to extend the scope of the regulation to other wooded land, and in two years whether it should be extended to other ecosystems (such as grasslands or wetlands) and other commodities (for example, maize or biofuels).

Overlap with other due diligence legislation

There is some overlap between the objective of the regulation and the recently agreed Corporate Sustainability Due Diligence Directive (CSDDD), which also imposes a due diligence process with the objective of mitigating adverse human rights and environmental impacts in companies’ value chains. The most significant difference between the two legislative acts is that the CSDDD applies to all value chains in companies over a certain size, and requires due diligence on social impacts, as well as a broad range of environmental impacts. In contrast, the deforestation-free regulation considers only the supply chains of specified products, and only requires due diligence specifically for deforestation and compliance with certain types of domestic laws. The deforestation-free regulation also applies to all companies, regardless of size (although there are some differences in obligations). The deforestation-free regulation will also be applicable before the CSDDD, which is likely to have effect from 2027. Despite these differences, there will be cases where supply chains are captured by both legislative acts. In this case, companies should be in a position to fulfil the reporting requirements under this regulation by including the required information when reporting under the CSDDD.

Implications for companies

The principal obligation placed on companies by the regulation is the need to produce a due diligence statement that verifies the product is deforestation-free and has been produced in accordance with the relevant legislation of the country of production. Without this due diligence statement, products cannot be sold in nor exported from the EU market.

The due diligence statement includes informational requirements, a risk assessment, and risk mitigation measures. The level of compliance will depend primarily on a risk benchmarking system developed by the Commission (Figure 1).

Figure 1: Informational, risk assessment and risk mitigation requirements included in the EU Regulation on deforestation-free supply chains.

The level of due diligence required by an individual company will depend on its position in the supply chain (whether it is an “operator”, an operator further down the supply chain, or a “trader”), and whether or not it is a small or medium sized enterprise (SME) (Figure 2).

Figure 2: Level of due diligence required for operators and traders.

Each Member State will be required to carry out checks on commodities and products subject to the regulation. The intensity of checks will vary according to the country of production’s risk level (when determined by the Commission) – for example, for high-risk countries Member States would be required to check 9% of total volume. Penalties for non-compliance include fines, with the maximum being set at least 4% of total annual turnover in the EU of the non-compliant company. Other possible penalties include confiscation of products or revenues, exclusion from public procurement or prohibition from selling in or exporting from the EU market.

The broad scope of the regulation means it is critical that companies begin to adapt to the requirements of the regulation now. The regulation will have a wide reach particularly in the consumer industry, affecting any company that sells or exports the relevant commodities and products in or from the EU, with varying levels of requirement depending on the position in the supply chain and the size of the company. It will affect almost all food retailers and wholesalers, as well as companies that sell products made from or derived from wood or rubber, such as furniture. As a first step, it will be key to establish in-depth oversight of all affected supply chains. Following this, companies will need to implement technologies that allow them to gather sufficient information to fulfil their due diligence requirements – the stringency of which will depend on the level of risk ascribed to the country of production. The Commission is currently piloting an information system with 100 stakeholders to facilitate the submission and processing of due diligence statements. Training on this will be available in mid-2024.

The Commission will assess within two years the need to extend it to include financial institutions, given their role in preventing financial flows that contribute to deforestation. Despite currently being excluded from the regulation, financial institutions should nevertheless consider the effect of the regulation on their corporate customers. This is because the increased scrutiny of supply chains may increase reputational risks for clients (and for the financial institutions that serve them) as well as affecting clients’ business model, profitability and viability.