Supplier due diligence critical for China-based suppliers

Australia imports a significant number of products from China each year, with the total value in recent years exceeding AUD 80 billion annually.  China is Australia’s largest trading partner with imports including potentially high-risk goods for modern slavery such as electrical and electronic equipment, machinery, vehicles and vehicle parts, textiles, medical apparatus and solar panels.

Using suppliers from China can pose significant risks for Australian companies due largely to the documented use of Uyghur forced labour in various industries, particularly in the Xinjiang Province. The Chinese government's extensive surveillance and repression in the region have led to concerns about widespread human rights abuses, including forced labour, which can taint supply chains even outside Xinjiang.

Australian companies must exercise heightened due diligence to effectively assess and address modern slavery risks among China-based suppliers. This involves conducting comprehensive supply chain audits, engaging independent third-party verifications, actively engaging suppliers and prioritising transparency by requiring detailed reporting from suppliers on their labour practices, within China and in subsidiary operations across Southeast Asia and elsewhere.

Here’s an example of what can happen when supplier due diligence isn’t undertaken.

Earlier this year, one of our clients entered a contract with a subsidiary of a China-based supplier.  The contract included modern slavery clauses to protect supply chain workers as well as the interests of our client in case of a possible breach. As part of the on-boarding process an on-site social compliance audit was undertaken of the supplier’s factory (located outside of China) from which the products were to be sourced.

Our client was subsequently made aware of the supplier’s inclusion on the US Department of Homeland Security’s (DHS) ‘Uyghur Forced Labor Prevention Act Entity List’ (under the Uyghur Forced Labor Prevention Act 2021, or UFLPA). According to the DHS website, the supplier is listed as an entity “working with the government of Xinjiang to recruit, transport, transfer, harbor or receive forced labour or Uyghurs, Kazakhs, Kyrgyz, or members of other persecuted groups out of Xinjiang”. The supplier denied the allegations, stating they were “based on false reports and complex international political reasons.”

While our client’s contract was with a China-based subsidiary of the supplier named on the US DHS Entity List and the products were manufactured by a non-China-based subsidiary of the supplier, it was felt that the risk of supply chain forced labour remained.

In line with its standard approach to supplier due diligence, our client immediately commissioned us to undertake a deep dive desk-top assessment of the supplier (via an online self-assessment questionnaire) to identify gaps and risks in the company’s approach to labour rights and broader human rights issues.

The results of the desk-top assessment identified significant red-flags including the provision of conflicting information, limited evidence of policies and risk management systems, use of intra-company suppliers (including subsidiaries located in the Xinjiang Province of China), lack of external verification of alleged alignment with international standards, and lack of documented grievance or remedy processes. These findings together with the supplier’s lack of engagement and transparency on the issue was a determining factor in our client’s decision to end the contract.

The key take-aways from this case study and important lessons for companies procuring from China based suppliers include:

1.        Thorough due diligence is crucial: The case underscores the importance of comprehensive due diligence at every stage of the procurement process – from planning, through sourcing and during contract management. Relying solely on social compliance audits may not reveal deeper risks, such as those associated with forced labour or debt bondage. Continuous engagement, assessment and verification are necessary, especially when dealing with high-risk regions or suppliers.

2.        Importance of supply chain transparency: The case highlights the need for transparency in the supply chain. The supplier's lack of clear information, coupled with the use of intra-company suppliers from high-risk areas like Xinjiang, raised red flags. Ensuring transparency helps in identifying potential risks early and making informed decisions. Asking potential suppliers a few strategic questions up front and undertaking desk-top research is critical. A simple Google search in this instance would have identified that the supplier was listed on the DHS Entity List.

3.        Legal and ethical considerations must align: Our client’s decision to terminate the contract reflects the importance of aligning legal obligations with ethical standards. Even if the contract was legally sound, the ethical implications of potential forced labour led to the decision to end the partnership, illustrating the need for businesses to consider both legal and ethical aspects in their operations. The outcome may have been different had the supplier agreed to engage proactively in discussions on the alleged impacts on workers and agreed to undertake actions to mitigate the risk.

4.        Responsiveness to emerging risks is essential: The case shows the importance of being responsive to new information and risks. On learning that the supplier was listed on the US DHS Entity List, our client quickly acted to reassess the situation. This response is crucial in mitigating risks and protecting the company’s reputation. Unfortunately, the response does little to protect the workers in the supply chain, particularly if other less ethical companies continue to use the supplier.

5.        Engagement and communication are key: The supplier’s lack of engagement and failure to provide consistent information were significant factors in the decision to end the contract. This underscores the importance of open and honest communication between suppliers and customers. A supplier’s willingness to engage and address concerns is critical in maintaining a successful and compliant business relationship.