Cutting deforestation out of supply chains:

• On 29 June 2024 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” and compliant with certain types of local laws. The rules will apply for large and medium enterprises from 30 December 2024. Companies could face fines in the realm of 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 Products 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, as well as companies who trade these products. 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 2025.
• The deadline for compliance is approaching quickly. 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 and systems that allow them to gather sufficient information to fulfil their due diligence requirements.
• 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 report by Forest 500 found that 40% of the companies and financial institutions with the most exposure to and influence on tropical deforestation have not yet set a policy on deforestation. This new EU Regulation on Deforestation-free Products (EUDR) 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 specified in Annex I, for example chocolate) 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 EUDR.

• “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 EUDR 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 EUDR 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 EUDR and the recent 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 EUDR 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 EUDR also applies to all companies, regardless of size (although there are some differences in obligations for small medium enterprises). The CSDDD will be applicable from 2027, but EUDR applies from 30 December 2024. Despite these differences, there will be cases where supply chains are captured by both legislative acts. In this case, companies who have supply chains captured by the EUDR should be able to use the information gathered for EUDR compliance to support with the requirements under the CSDDD.
 

Implications for companies
 

The principal obligation placed on companies by the EUDR 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 process includes three separate steps: informational requirements, a risk assessment, and risk mitigation measures (Figure 1). A simplified due diligence process that only requires collection of the informational requirements is available to countries considered low risk by the EU Commission, however this risk benchmarking has not yet been released. Until it is released, all countries are to be considered “standard risk” meaning a risk assessment is required.
 

Figure 1: Informational, risk assessment and risk mitigation requirements included in the EUDR 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 EUDR. 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. In addition, companies importing or exporting relevant commodities or goods without a compliant due diligence statement run the risk of having their shipments held up or turned away at the EU border.  

The broad scope of the EUDR (and its fast approaching implementation deadline) means it is critical that companies begin to adapt to its requirements now. The EUDR 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, and implement a risk assessment methodology to ensure the accuracy of that information. The Commission is currently developing an information system to facilitate the submission and processing of due diligence statements. Registration to use the system will begin in November 2024 and the system will be open to all users in December 2024.

The Commission will assess within two years the need to extend the EUDR to include financial institutions, given their role in preventing financial flows that contribute to deforestation. Despite currently being excluded from the EUDR, financial institutions should nevertheless consider its effect 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.

This is an update of a previous version of the blog
 

Key contributor:
Laura MacKay – Senior Legal Sustainability Consultant – Deloitte Legal Netherlands