Supply-chain compliance and due diligence in Estonia

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published on 15 September 2022 | reading time approx. 5 minutes

by Ilona Nurmela


Supplying and distributing a specific product or service from the beginning to end is what is known as the supply chain process (involving sourcing of materials, R&D, manu­facture, finance, customer service, distribution & marketing). A 2015 survey from Cone Communications[1] found that 9 out of 10 millennials would switch brands to one associated with a more ethical cause – for a $100 product, customers were willing to pay an average of $27 more, if it were made under good working conditions, $19.50 more if the production's carbon emissions were offset and $18.50 more, if the raw materials were ethically sourced. This is why supply chain compliance and ESG (Environmental Social Responsibility) have been a concern in recent M&A deals, due diligences and investment opportunities – investors want to know what risks they are open to, if the business they want to invest in should turn out to be not ethical at some point in the chain.

 

 

Integration of Corporate Social Responsibility and Environmental Social Responsibility in Estonia

CSR (Corporate Social Responsibility) and now ESG are part of responsibly doing business in Estonia. Making sustainable reporting and due diligence mandatory has been creeping up on Estonia via various EU Regu­la­tions.

First there was Regulation (EU) No 995/2010 of the European Parliament and of the Council of 20 October 2010 (in force from 2013) laying down the obligations of operators, who place timber and timber products on the EU market, to certify their products (FLEGT/CITES license or permit) in order to stop the trade in illegally harvested timber and timber products.

Next, in 2014 there was EU Non-financial Reporting Directive (NFRD) Directive 2014/95/EU requiring from 2018 onwards for large companies to publish information on implemented environmental, CSR and HR policies, in­clu­ding information on human rights, anti-corruption and bribery, and diversity on company boards. The focus was also on due diligence procedures throughout the supply chain with a view to addressing existing and po­ten­tial negative effects. For some strange reason only the diversity element (read: women) on company boards caused a stir in media, but perhaps that was because the NFRD did not exactly impose a legal obli­gation on EU companies to undertake due diligence regarding human rights compliance. The regulation offered an easy way out – a “comply of explain” principle – i.e. if companies do undertake the due diligence, they are required to report on it and if they don’t, they are required to explain why they do not.

Then there was EU Regulation (EU) 2017/821 laying down supply chain due diligence obligations for EU im­porters of tin, tantalum and tungsten, their ores, and gold originating from conflict-affected and high-risk areas, making them check that the minerals or metals they buy do not contribute to conflict, forced labour or other illicit activities.

Now there has been a proposal to pass (and from 2023 also implement) a new EU Regulation on supply-chain compliance where human rights and environmental practices are concerned, with fines and rights for victims to sue for damages in case of non-compliance [2].


Current situation regarding Corporate Social Responsibility and Environmental Social Responsibility reporting in Estonia

In Estonia, CSR/ESG reporting is largely voluntary, but the pressure from investors and even employees has made companies realise that the reflected need for more transparency means ESG reporting is, indeed, im­por­tant. NASDAQ e.g., has developed ESG programmes for stock exchanges to be implemented for companies listed on NASDAQ Nordic and NASDAQ OMX Tallinn. Listed companies include and publish CSR reports in their annual audited reports. There are also a few consulting companies like Sustinere who regularly analyse the level of sustainability disclosures in the Baltics. As at 31.12.2019, according to Sustinere’s report[3] listed and state-owned companies are ahead in voluntary sustainability and environmental impact reporting, while locally owned large firms lag behind. Only 1/5 of the Top 100 largest Estonian companies report on ESG sys­tematically and comprehensively and only 1/3 of disclosures are supported with numeric, measured data. Surprisingly, state-owned enterprises report more on ESG than listed companies (as per 2019 data available).

Quite a lot of Estonian companies have codes of business ethics or codes of conduct, outlining the principles of sustainable business, including adherence to human rights and protection of the environment. After realising that 98% of the financial sector’s environmental impact is in its supply chain (compared to direct operations), a few Estonian investment firms have voluntarily joined the PRI (Principles of Responsible Investing) ESG ini­tia­tive of institutional investors acting sustainably in the best interests of their beneficiaries. From 2014 PRI has two Estonian signatories and third company joined in 2020[4]:


Impact of the environmental social responsibility obligation on companies in Estonia

Out of the 13,000 EU firms that the proposed EU supply-chain legislation is supposed to impact – i.e. for which ESG shall be mandatory, not voluntary – very few firms are located in Estonia. The thresholds of application are:

  1. Firms employing more than 500 people with a turnover of more than 150 million EUR; OR
  2. Firms employing 250 people with a turnover of more than 40 million EUR in the following sectors: clothes, animals, forestry, food & beverages, extraction of fossil fuels & metals.

In 2020, there were 155 companies in Estonia with 250 or more employees, but their aggregate turnover is a little more than 12,5 Million EUR, i.e. in 2022 there were no companies that have 250+ employees AND 40+ Million EUR turnover in Estonia[5]. Data on 2021 is not currently available, however it is estimated that by 2023 there will be several Estonian companies which will fall under EU supply-chain obligation. However, even if formal requirements are not fulfilled by many Estonian companies, it does not mean that Estonian companies won’t be affected at all since the EU rules state that the supply-chain legislation will apply to non-EU firms that reach the above-mentioned turnover thresholds when generated in the EU. Furthermore, companies in the affected sectors – clothes, animals, forestry, food and beverages, extraction of fossil fuels and metals[6] – should tread carefully, especially if operating across quite a few EU member states.


Assessment of environmental social responsibility risks as part of M&A transactions

In Estonia, ESG risks are assessed in most M&A transactions in the course of legal due diligences. ISO certi­fication, sourcing certification and recycling is the new “normal”. More and more firms develop policies for CSR/ESG, ethical business, HR, environmental protection and commit to reducing carbon dioxide emissions or report on being carbon-neutral, but very few metrics can be found on company websites.


Potential risk factors in Estonia

Besides the industry sectors mentioned above, other risk factors may trigger application of the EU chain-supply legislation when measuring and reporting on compliance:

  • Procurement: The term used for wins on price only is an area to watch out for as the trend in public pro­cure­ment is to highlight price as the decisive win factor, but there has been a move away from price-only-policies as of late;
  • Work safety: The treatment of employees and the instability of the workforce instability are the main focus of this area. While it’s not slave or child labour that you need to worry about in Estonia the number of work accidents is, according to the Labour Inspectorate, the highest in the following sectors: Chemical manu­fac­tu­ring, transport (especially truck drivers), timber and commercial premises[7]. Also, not a lot of companies report on the number of days without accidents on their websites or annual reports, even though the stands with this information may be up on actual working.
  • Environment: More and more – but still not enough – companies measure their CO2 footprint and report on GRI or Global Compact measures.
  • Corruption: Some companies operating in Estonia that have HQs in the West, the Nordics and in Japan have policies and report on gifts and donations, but this practice is not widespread; such kind of reporting is mandatory for the politically exposed persons, including those who are on the Supervisory Boards or on the Management Boards of state-owned companies.
  • Human rights – according to the 10.12.2021 report by the Estonian Human Rights Centre, the human rights situation in Estonia has deteriorated over the last two years. Regarding companies, the risk factors are: Unequal treatment of employees and non-GDPR-compliant retention of telecommunications data[8].


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