Supply Chain Due Diligence | The Growing Need for Transparency and Compliance

Elon Musk once said, “The supply chain stuff is really tricky.”  Tricky parts come later; very often, companies don’t even have a proper program. Yes, 80% of firms lack supplier due diligence measures. A crucial aspect of getting supply chains ready for potential risks in the business ahead, as per the report of ECOVADIS.

Today, global businesses are facing the challenge of a constantly evolving legal and regulatory environment in order to keep their supply chain ethical, transparent, and free of illegal activities.

A company’s reputation and financial health operating in the supply chain sector now depend not only on the practices followed within its own value chain but on the practices of entities within it. 

Failure to conduct proper supply chain due diligence is risky as it can lead to heavy penalties, legal repercussions, asset loss, and damage to credibility.

Let’s break down the concept of what supply chain due diligence is, related international regulations, and the repercussions of non-compliance. 

What is Supply Chain Due Diligence?

The Supply chain due diligence process comprehensively evaluates and monitors all entities involved in a business’s supply chain. It includes all the business partners, UBOs, directors, and main stakeholders of the company. It ensures that clients or partner entities comply with legal, global, ethical, and sustainability laws and standards.

The process is more than simply verifying suppliers’ business licenses. One of the major aspects includes verifying ownership structures and identifying potential risks associated with supply chain business entities. 

It not only ensures that all labor practices and supplier compliance are thoroughly assessed but also properly monitored and managed to meet the regulatory requirements.

Supply chain due diligence entails evaluating entities involved in the supply chain for their potential involvement in fraud, embezzlement, abuse of basic human rights, ESG violations, and labor law violations. 

In essence, it’s all about staying aware of who you’re doing business with, all the way down the supply chain, to avoid financial, legal, reputational, and ethical risks.

Importance of Supply Chain Due Diligence

Carrying forward the concept of supply chain due diligence, one of the significant benefits of this process is that it helps businesses avoid risk and make better decisions. By carefully checking their suppliers and partner entities, companies can ensure they are not involved in any illegal activity or labor practices that may be considered suspicious. 

Let’s see what global regulations have to say on supply chain due diligence.

Global Laws for Supply Chain Due Diligence

Global regulations primarily prioritize ethical sourcing and clarity in the supply chain sectors. 

Government authorities are empowering organizations to implement proper due diligence that ensures that their suppliers comply with environmental standards, labor laws, and human rights principles. 

These laws demand more comprehensive KYB checks into supply chains and, importantly, transparency into ownership hierarchies.

Let’s explore some of the major regulations that make due diligence mandatory in supply chains across the globe:

• Uyghur Forced Labor Prevention Act (UFLPA) – United States 

The UFLPA mandates that goods made in the Xinjiang Uyghur Autonomous Region of China or by certain listed entities cannot be imported into the United States unless companies prove that the goods were not made with illicit labor practices. 

Businesses are required to provide complete transparency in their supply chains and be able to prove that no part of their supply chain is associated with forced labor, particularly in regions like Xinjiang, in order to comply with this law. 

To ensure proper due diligence according to this law, Ultimate Beneficial Owner identification is essential. The KYB due diligence process screens warnings and regulatory enforcement data to check involvement in potential violations of fundamental human rights and labor laws.

• EU Corporate Sustainability Due Diligence Directive (CSDDD) – European Union (2024/2025)

The CSDDD requires large companies (with more than 1,000 employees) in the European Union to identify, prevent, and reduce negative impacts that are explicitly related to human rights and the environment throughout their value chains. 

The directive makes it mandatory for businesses to conduct due diligence on their suppliers, ensuring that ownership structures are not involved in money laundering or associated with unethical practices. 

Note that legal entity verification also plays a crucial part in meeting the requirements of this directive.

• California Transparency in Supply Chains Act (CTSCA) – United States

The CTSCA requires large companies (those with annual revenue over $100 million) to provide proper details about the efforts they implement to combat slavery and human trafficking within their supply chains.

This law mandates companies to take a step further that goes beyond self-reporting and regularly auditing their suppliers. Moreover, companies have to provide clear and transparent information regarding the practices for their supplier verification, auditing, certifications, and accountability systems. 

In addition to this, CTSCA also requires that companies make these disclosures available on their websites. By enforcing this regulation, the goal of California is to push companies to fully vet their supply chains, ensuring that every link is free from exploitative labor practices. 

The KYB due diligence helps vet that the suppliers are not involved in unethical or illegal practices.

• German Supply Chain Due Diligence Act (LkSG) – Germany 

The German Supply Chain Due Diligence Act requires large companies in Germany (with more than 3,000 employees) to ensure that their supply chains comply with human rights and environmental standards. 

These businesses are required to conduct risk assessments, establish preventive measures, and take corrective actions when violations occur. The law also requires companies to implement a complaints mechanism for affected parties. 

Under LkSG, organizations must go beyond simple supplier due diligence and opt for enhanced due diligence to understand the ownership structure of the entities in their supply chains. 

It is necessary to ensure that companies are dealing with suppliers whose owners have no history of human rights abuses or environmental harm.

Why Legal Entity Identification and UBO Screening Matter?

In addition to the regulations themselves, companies should take proactive steps to ensure that their suppliers adhere to administrative and global regulations. 

One of the most critical aspects of this is understanding who owns and controls the companies in the supply chain. Here’s why business verification and UBO screening are essential:

• Identify Hidden Risks

Many supply chain violations happen deep within the supplier network, where hidden risks may not be immediately visible. Legal entity verification allows businesses to trace ownership back to individuals or entities that may be involved in illicit activities. 

If a supplier’s ultimate owners are involved in forced labor, human trafficking, or environmental violations, those risks can affect the business higher up the chain.

• Mitigate Exposure to Sanctions and Financial Crimes

Businesses are increasingly held responsible for the activities of their suppliers. If a supplier is linked to a sanctioned entity or individual, the company itself could face fines, penalties, or even be blacklisted. Regulations such as the OFAC, EU Sanctions, and Global Affairs Canada Sanctions have clear expectations for companies to monitor and investigate the ownership structures of their suppliers. Failing to do so could result in sanctions violations or fines.

International sanctions regimes—such as those enforced by OFAC against Russian entities—require companies to scrutinize the ownership structures of their suppliers, especially to detect links to sanctioned individuals or entities.

• Ensure Ethical Practices

A thorough UBO screening against sanctions lists, watchlists, and regulatory enforcement processes ensures that a business’s suppliers are not involved in unethical practices such as child labor, forced labor, or environmental harm. 

By ensuring that the owners of supply chain businesses comply with legal and ethical regulations, companies can strengthen their corporate social responsibility (CSR) efforts and build a reputation for responsible sourcing.

• Meet Regulatory Requirements

Laws such as the CTSCA and UFLPA require companies to conduct due diligence on their suppliers and confirm they’re not violating any rules.

Without know your business process for supply chain due diligence, businesses may fail to meet regulatory obligations, risking legal penalties and damage to their reputation.

What are the Consequences of Non-Compliance in Supply Chain?

The consequences of failing to comply with supply chain due diligence regulations can be severe. Below are a few examples of real-world cases where businesses faced penalties or legal issues due to violations of supply chain due diligence laws:

1. OFAC Fine on e.l.f. Cosmetics 

In 2019, OFAC fined e.l.f. cosmetics for importing goods that were linked to North Korean forced labor. The company failed to conduct adequate due diligence on its suppliers, resulting in a fine of nearly $1 million. 

This case highlights the importance of business verification in preventing companies from being inadvertently associated with sanctioned entities.

2. UFLPA Enforcement Actions

Since the implementation of the UFLPA, U.S. Customs has detained over 3,200 shipments valued at nearly $1 billion. These shipments were flagged for possible links to forced labor. In many cases, businesses were unable to prove the ethical sourcing of their goods, resulting in delays and product seizures.

3. UK Modern Slavery Act Enforcement

The UK Modern Slavery Act requires companies to disclose their actions to combat slavery and human trafficking. Companies that fail to disclose or inadequately address these issues face reputational harm and potential legal challenges. 

Some businesses have been scrutinized for not properly investigating their suppliers or failing to uncover the ownership structures of their supply chain partners.

How The KYB for Supply Chain Due Diligence Gets You All Covered 

Supply chain due diligence is no longer just a voluntary action; it is now a legal requirement. With regulations such as the UFLPA, CTSCA, and German Supply Chain Due Diligence Act, businesses must ensure complete visibility and transparency into their supply chains.

The key to compliance lies in thoroughly screening suppliers and understanding UBOs. The KYB’s Supply Chain Due Diligence solution empowers your business to verify legal entities with precision, ensuring every supplier, vendor, or third-party meets global compliance standards.

With integrated AML screening, businesses can screen UBOs and legal entities against watchlists and warning & regulatory enforcement. It is the core that helps in supply chain due diligence through a seamless API.

Don’t wait for risk to surface; identify it before it enters your business network. The KYB gives you the solution to stay ahead, stay transparent, and stay protected. Contact us or book a demo from the website.

Frequently Asked Questions 

1. What is Supply Chain Due Diligence Act?

The Supply Chain Due Diligence Act is a legal framework that requires companies to identify and address human rights and environmental risks within their supply chains. It mandates proactive monitoring and  risk assessment to ensure responsible business conduct