For more than a century, there have been regulations mandating companies’ responsibilities in supply chains and the production or importation of products they sell. Many of these have not been as effective as desired. The past decade has thereby seen an explosion in laws compelling companies to dramatically improve their supply chain and ESG monitoring and management. This is driving broader implementation of processes and technologies that were previously implemented by only a minority of companies in the past, but now must be widely adopted across industries. This includes capabilities such as end-to-end traceability, multi-tier supply chain mapping, and more rigorous auditing of working conditions across multi-tier supply chains. In this series, we look at the goals of these regulations, the impact on companies’ processes and systems, and how different companies are reckoning with compliance. Part one (this article) focuses on the goals of ESG/SCRM-related regulations.
Regulatory Legislation, a Response to Detrimental Events
Regulations often arise in response to a major harmful or detrimental event or an accumulation of smaller individual harms. Thus, each ESG and supply chain-related regulation is created with a specific set of purposes or goals in mind. Below we explore some of the more common goals of ESG and supply chain regulations. In part two of this series, we will discuss the impact of these regulations on a company’s processes and systems.
Anti-counterfeiting
Some regulations, in particular ones mandating traceability, have anti-counterfeiting as their primary aim. Examples include most of the pharmaceutical regulations requiring end-to-end traceability, such as DSCSA (US), FMD (EU), NMPA (China), Drugs Amendment 2022 (India), NAFDAC (Nigeria), and more than a dozen other countries’ regulations. Rates of pharmaceutical counterfeiting vary widely across the world.[1]
Safety/Recall Efficiency
Some regulations’ primary goal is to increase product safety. This is often done by making recalls more rapid and effective. A key example is Section 204d Traceability Requirements of the Food Safety Modernization Act (FSMA). Per the FDA’s main page summarizing this rule (aka Requirements for Additional Traceability Records for Certain Foods) states: “The new requirements identified in the final rule will allow for faster identification and rapid removal of potentially contaminated food from the market, resulting in fewer foodborne illnesses and/or deaths.” Pharmaceutical traceability regulations key goals include product safety,[2] rapid quarantining, and comprehensive, effective recall of suspect drugs.[3]
Safety is also the primary motivation for back-to-birth traceability of life-limited airplane parts. Such traceability is not strictly required by law,[4] but regulations do require a record of current life status for life-limited parts. To ensure compliance, the industry has settled on back-to-birth traceability as a de facto requirement for life-limited parts.[5]
Labor Conditions, Anti-slavery, and Human Rights
Importing products produced with forced labor has been illegal in the U.S. for almost a century per Section 307 of the Tariff Act of 1930 (19 U.S.C. §1307).[6] This act and anti-slavery regulations in Europe and other regions have been supplemented by more specific legislation, especially in the last decade, such as the U.S.’s Uyghur Forced Labor Prevention Act (UFLPA), the EU’s proposed Forced Labour Regulations, the U.K.’s Modern Slavery Act 2015 (Section 54, Transparency in Supply Chain Provisions), and the German Supply Chain Due Diligence Act (LkSG). Some of these regulations focus primarily on reporting and transparency. For example, the UK’s MSA 2015 says it “aims to ensure that major businesses are transparent about what they are doing to tackle modern slavery.”[7] Other regulations are more targeted and prescriptive. For example, the UFLPA directs the Customs and Border Protection (CBP) to presume that anything produced in the Xinjiang province of China was produced with slave labor, unless the CBP commissioner certifies that a particular shipment of goods has not been made with forced labor.
Climate Change and Emissions Tracking
Lawmakers and regulators have responded to the unfolding climate change crisis by proposing and implementing a variety of regulations. The SEC’s proposed rule, The Enhancement and Standardization of Climate-Related Disclosures for Investors,[8] helps provide investors with the information they need to understand the climate-related risks to their investments. The proposed rule would require all public companies traded on U.S. exchanges to disclose specific information on climate-related risks to their business and the likely impact on the firm’s strategy, business model, outlook, and financial results. The rule also requires disclosure of scope 1, 2, and 3 greenhouse gas (GHG) emissions.[9] The scope 3 reporting requires reporting emissions from all activities up and down the supply chain.
Other regulations directly incentivize the lowering of emissions. For example, the EU Emissions Trading System (EU ETS) is a cap-and-trade system[10] covering emissions from about 10,000 facilities in the energy and manufacturing sectors. Since this system requires payment for carbon emissions beyond the allowances granted to companies, it potentially puts those European companies at a competitive disadvantage compared with companies outside the EU that are not paying for their emissions. To compensate for that disadvantage, the EU has implemented its Carbon Border Adjustment Mechanism (CBAM).[11] CBAM requires reporting of the embedded emissions[12] on imports—i.e., all the upstream scope 3 emissions that it took to produce and transport the imported items/materials—to ensure a fair price is paid for those emissions.
Defunding Conflict Zones and Belligerent States
Some areas of the world suffer from seemingly intractable perpetual conflicts and civil wars.[13] Various regulations are designed to reduce the sources of funds financing these conflicts. For example, the EU’s Conflict Minerals Regulation, and in the U.S., Section 1502 of the Dodd-Frank Act both aim to ensure that the “3TG” minerals (tin, tantalum, tungsten, and gold) are not being sourced from illegal mines that are funding conflicts (while also using forced labor). The Kimberly Process is a multilateral trade regime established to prevent the flow of conflict diamonds (rough diamonds used to finance wars). It is enforced in the U.S. by the Clean Diamond Trade Act and in the EU by EC 2368/2002.
Sanctions against specific actors in Russia, Iran, North Korea, and many other countries[14] have been imposed in response to their involvement as belligerents in wars (e.g., Russia’s invasion of Ukraine), proxy wars and conflict funding (e.g., Iran’s support of Yemen rebels, Hamas, Hezbollah, and other violent groups), and to attempt to deter the development of nuclear weapons by Iran and North Korea.
Restrict harmful substances in products
Some legislation is designed to limit the use of harmful and hazardous ingredients in products. Examples include the EU’s Registration, Evaluation, Authorisation, and Restriction of Chemicals (REACH), and Restriction of Hazardous Substances (RoHS). U.S. regulations on harmful substances include the Toxic Substances Control Act of 1976 (TSCA), Food, Drug, and Cosmetic Act (FDCA, aka Title 21),[15] the Consumer Product Safety Improvement Act (CPSIA), the Federal Hazardous Substances Act (FHSA), and various other regulations restricting the use of heavy metals in products,[16] as well as initiatives like the FDA’s Closer to Zero program. There are also state-level regulations as well, such as the recently signed AB 899 mandating testing for arsenic, cadmium, lead, and mercury in baby food sold in California.
Biodiversity and Habitat Preservation
As the world’s population has ballooned to over eight billion people, the preservation of rapidly shrinking natural habitats and biodiversity has become increasingly critical, prompting many regulations aimed at protecting wildlife and habitats. In the U.S. this includes the Lacey Act (banning the trade of illegally captured wildlife and plants, such as illegal logging),[17] Endangered Species Act (ESA), the Clean Water Act (CWA), Magnuson-Stevens Fishery Conservation and Management Act (MSA), and the Migratory Bird Treaty Act (MBTA). European regulations include the 1979 Bern Convention, the Wild Birds Directive (79/409/EEC), Habitats Directive (92/43/EEC), Water Framework Directive (WFD), Environmental Liability Directive (ELD), Groundwater Directive (GWD), 1991 Nitrates Directive (91/676/EEC), Council Regulation No 1590 (1590/98), EU Deforestation Regulation (EUDR), and Shellfish Waters Directive (SWD), as well as newer legislation being considered such as the Nature Restoration Law (NRL).
Many of these regulations are in response to international treaties protecting wildlife and habitats, such as The Convention on International Trade in Endangered Species of Wild Fauna and Flora (CITES), the Convention on the Conservation of Migratory Species of Wild Animals (CMS, aka The Bonn Convention), the Convention on Wetlands (Ramsar Convention), the 1972 World Heritage Convention (WHC), and The 1992 OSPAR Convention.
Circular Economy
The world faces dual crises resulting from a combination of massive population growth and the current linear economy model (i.e., “a system in which people buy a product, use it, and then throw it away”). The resulting two crises are: 1) massive quantities of waste clogging and degrading the global environment and 2) the planet’s natural resources being depleted due to excessive extraction. These two crises are compelling countries to adopt policies and legislation to promote a more circular economy, defined as “a model of production and consumption, which involves sharing, leasing, reusing, repairing, refurbishing and recycling existing materials and products as long as possible.”[18]
The EU has been a leader in promoting a circular economy through legislation such as the Waste Framework Directive (WFD), Packaging and Packaging Waste Directive (PPWD), Directive on Waste from Electrical and Electronic Equipment (WEEE), and End-of-Life Vehicles Directive (ELV). Looking forward, the EU has adopted a new and relatively ambitious Circular Economy Action Plan (CEAP), which includes its Sustainable Products Initiative (SPI). The CEAP is a key element of the European Green Deal.
Japan also has adopted ambitious circular economy legislation. The foundation for Japan’s circular economy initiatives is their Basic Law for Establishing the Recycling-based Society” (Law #110 of 2000) and Law for the Promotion of Effective Utilization of Resources. Japanese circular economy regulations also include the Basic Environmental Law (Law #91 of 1993), Law for Promotion of Sorted Collection and Recycling of Containers and Packaging (Container and Packaging Recycling Law), Law for the Recycling of Specified Kinds of Home Appliances (Home Appliance Recycling Law), Act on Promoting Food Loss Reduction (Food Loss Act), Construction Material Recycling Law, the Act on Promotion of Procurement of Eco-Friendly Goods and Services by the State and Other Entities (Act on Promoting Green Purchasing), and the Law for the Recycling of End-of-Life Vehicles (End-of-Life Vehicle Recycling Law).
In 2008, China passed its Circular Economy Promotion Law, a national economic and social development strategy mandating that new industrial policies created by the government must promote a circular economy. China’s 12th, 13th, and 14th Five-Year Plans all contain circular economy elements and targets.
The U.S. is behind the EU, Japan, and China in enacting federal circular economy legislation. There are state-level beverage container recycling laws in about a dozen states. Several states also have electrical and electronic recycling laws, but there is no federal law or consistency between the states.
Socially Responsible Investing
Socially Responsible Investing (SRI) has become a major force in global investments, accounting for between $17T and $35T of assets under management (i.e., a third or more of all assets under management) according to various sources. This phenomenon is discussed in more detail in Achieving Transparency, Risk Reduction, and Impact with ESG Investing—Part One: Types of ESG Investing, how it generates value, and how ESG is measured.
Different countries and regions are responding to this explosion in socially responsible investing with various legislation. The EU is a leader in supporting SRI, via their EU Sustainable Finance Action Plan (SFAP), one of three components of The European Green Deal Investment Plan (EGDIP). SFAP encompasses the EU Taxonomy Regulation, the Sustainable Financial Disclosure Regulation (SFDR), the Corporate Sustainable Reporting Directive (CSRD), the EU Climate Transition Benchmark Regulation and Paris-Alignment Benchmark Regulation (2020/1818), Markets in Financial Instruments Directive II (MiFID II), and EU Green Bonds Standard.
In the U.S., ESG has become a political issue, resulting in opposing state laws, some promoting and some discouraging socially responsible (or ESG) investing. As mentioned above, the SEC has proposed a rule, The Enhancement and Standardization of Climate-Related Disclosures for Investors, to provide investors with the information they need to understand the risks to their investments. This should help SRI funds to better evaluate whether public companies meet their investment criteria. In 2021, President Biden issued an Executive Order on Climate-Related Financial Risk to “advance accurate disclosure of climate-related financial risk” among other goals. Earlier this year, the Congressional Sustainable Investment Caucus endorsed the proposed Freedom to Invest in a Sustainable Future Act.
Anti-corruption and Bribery Prevention
Various legislation aims to curtail corruption and bribery across global supply chains. This includes the EU’s Corporate Sustainability Reporting Directive (CSRD) and the U.S.’s Foreign Corrupt Practices Act (FCPA).
The tidal wave of global regulations for ESG and supply chains seen over the past decade or two is broad and ambitious, encompassing a diverse set of goals as outlined above. This legislation is having a profound impact on how companies are run—their strategies, policies, processes, and systems. In Part Two of this series, we cover the impact and implications of these regulations on companies’ processes and systems.
Appendix A—Table 1: List of Some ESG/SCRM-related Regulations and Their Goals
Source: ChainLink Research
Table 1 – Goals of Various ESG and Supply Chain Risk Regulations
| Key: ✔✔ = Primary Goal ✔ = Secondary Goal |
[1] Estimates of worldwide counterfeit drugs sold are all over the map, ranging from 2 percent to 10 percent, and value estimates from $4B (OECD, Trade in Counterfeit Pharmaceutical Products) to $431B (Fraud in Your Pill Bottle: The Unacceptable Cost of Counterfeit Medicines, Henry Miller, M.S., M.D. and Wayne Winegarden, Ph.D. October 2020, Pacific Research Institute). Our research indicates that global counterfeit drugs sales are around $40B or about 3% to 3½% of the global prescription and OTC pharmaceuticals market. In developed countries, it is typically 1% or less. In some regions, such as India and Sub-Saharan Africa, counterfeits account for 25%-30% or more of all pharmaceuticals sold. — Return to article text above
[2] I.e., preventing adulterated/counterfeit drugs from entering the supply chain. — Return to article text above
[3] According to What Are the Drug Supply Chain Security Act’s Key Provisions?, “Over a 10-year period, the DSCSA should be able to … aid in a more successful drug recall situation. The overarching purpose of this new law is to more efficiently ensure patient safety by preventing illegitimate or recalled drug products from entering the market.” — Return to article text above
[4] Though not a regulatory requirement, the FAA does provide guidelines for traceability such as with their Advisory Circular #20-154, Guide for Developing a Receiving Inspection System for Aircraft Parts and Material. — Return to article text above
[5] The Parts Traceability Puzzle has more details about FAA requirements for aircraft parts traceability. — Return to article text above
[6] According to the Congressional Research Service’s July 2022 publication, Section 307 and Imports Produced by Forced Labor, “Section 307 of the Tariff Act of 1930 (19 U.S.C. §1307) prohibits importing any product that was mined, produced, or manufactured wholly or in part by forced labor, including forced or indentured child labor. U.S. Customs and Border Protection (CBP) enforces the prohibition.” This expands on the 1890 McKinley Tariff Act which already banned the import of products made with prisoner labor. However, enforcement of Section 307 has been sparse and episodic. Since the act went into effect in 1930, there have been fewer than 150 WROs (withhold release orders) or equivalent issued under this act, and many of those were successfully contested. The challenges of enforcement have been one of the drivers of more recent anti-slavery legislations, which appear to be somewhat more effective, at least based on the number of shipments affected. For example, over 5,500 shipments were affected by UFLPA in the 16 months from June 2022 to September 2023, and almost 2,500 of those were denied entry, per the CBP’s UFLPA statistics dashboard. — Return to article text above
[7] The MSA 2015 memorandum goes on to say “Businesses above a specified turnover threshold of £36m will be required to produce a slavery and trafficking statement for each financial year of the organisation.” — Return to article text above
[8] The SEC makes a persuasive case that this rule is part of its core mission statement. The SEC’s website describes three pillars to its mission statement: 1) protecting investors; 2) maintaining fair, orderly, and efficient markets; and 3) facilitating capital formation. They also say that this rule has wide support in the business community. Their March 2022 press release (SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors) says “investors representing literally tens of trillions of dollars support climate-related disclosures because they recognize that climate risks can pose significant financial risks to companies.” — Return to article text above
[9] According to the SEC’s March 2022 press release, “The proposed [GHG emissions] disclosures are similar to those that many companies already provide based on broadly accepted disclosure frameworks, such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol.” — Return to article text above
[10] “Cap-and-trade sets the quantity of emissions reductions and lets the market determine the price.”, per Pricing Carbon: A Carbon Tax or Cap-And-Trade? — Return to article text above
[11] CBAM takes effect in 2026, but the first reporting requirements started on October 1st, 2023. — Return to article text above
[12] “Embedded emissions” and “embodied carbon” are equivalent terms according to E3G as stated in Embodied carbon emissions: meaning and measurements: “Embodied carbon emissions of goods, also known as embedded carbon emissions, refer to the greenhouse gas emissions generated during the production and transportation of goods, from the extraction of raw materials to the manufacturing process and final delivery to the consumer.” — Return to article text above
[13] Examples of areas suffering from decades-long protracted conflicts include the DRC (Democratic Republic of Congo), the Central Sahel region (Burkina Faso, Mali, Niger, Nigeria), the Middle East (Syria, Lebanon, Yemen, Israel/Palestine), the Horn of Africa (Sudan, Ethiopia, Eritrea), and Myanmar. — Return to article text above
[14] A list of U.S. sanctions by country and category can be found on the U.S. Treasury Department’s web page Sanctions Programs and Country Information. — Return to article text above
[15] Title 21 of the code of Federal Regulations (21 CFR) contains several sections regulating the use of certain substances within cosmetics such as Subpart D, section 250.250 (Requirements for Drugs and Cosmetics – Hexachlorophene), Subpart B, sections 700.11-700.35 (Requirements for Specific Cosmetic Products), Subpart C, sections 701.20-701.30 (Labeling of Specific Ingredients), and Part 740 (Cosmetic Product Warning Statements). — Return to article text above
[16] U.S. regulations on the use of heavy metals include 16 CFR Part 1303 – Ban of lead-containing paint and certain consumer products bearing lead-containing paint, 16 CFR Part 1500.87 – Children’s products containing lead: inaccessible component parts, the Consumer Product Safety Improvement Act (CPSIA): Children’s Products, the Federal Hazardous Substances Act (FHSA): Household Products, Food, Drug, and Cosmetic Act (FDCA), Toxic Substances Control Act (TSCA), Mercury-Containing and Rechargeable Battery Management Act, and various State-level heavy metal regulations. — Return to article text above
[17] The Lacey Act, introduced in 1900, bans interstate or foreign commerce involving fish, wildlife, or plants taken, possessed, or sold in violation of state or foreign law. It was amended in 2008 and provides tools to combat illegal logging worldwide. Per the Siera Club’s description, “The Lacey Act requires importers of wood products to take steps to ensure that their products have been sourced legally, with violators facing fines or jail time.” — Return to article text above
[18] This definition is from the EU Parliament’s Circular economy: definition, importance, and benefits. — Return to article text above