Clifford Chance

On the first day of 2021, the EU Conflict Minerals Regulation will become operative, requiring numerous companies in the automotive, chemical, pharmaceutical and other industries to act now to implement due diligence assessments and other compliance measures.

Context: Increasing due diligence requirements

The Conflict Minerals Regulation (Regulation (EU) 2017/821 of 17 May 2017) is the first act at EU level imposing mandatory due diligence on private entities to protect human rights in conflict areas, and may become a blueprint for more general supply chain requirements, such as the legislative initiative announced on 29 April 2020 by EU Justice Commissioner Didier Reynders. Under this initiative, the Commission plans to introduce EU-wide due diligence requirements for businesses to respect human rights and prevent environmental harm across their global supply chains (see our recent blog post). The draft legislation is expected in early 2021.

Conflict Minerals Regulation

Regulation (EU) 2017/821 ('Conflict Minerals Regulation') imposes supply chain due diligence obligations for importers of certain metals and minerals originating from conflict-affected and high-risk areas. The Regulation aims at controlling the trade of minerals from such areas to help eliminate the financing of armed groups and prevent severe human rights violations.

Affected minerals

The Regulation applies to the so-called '3TGs,' meaning minerals and metals containing or consisting of tin, tantalum, tungsten (3T) and gold (G). The 3TGs are the minerals and metals most often associated with armed conflict and related human rights violations in certain countries.

Affected businesses

3TGs are a critical resource for the electronics, automotive, aviation, chemical and pharmaceutical industries. The Regulation imposes obligations on 'union importers,' defined as 'any natural or legal person declaring minerals or metals for release for free circulation' meeting further EU law requirements. However, the Regulation is only applicable if the annual import volume is above certain thresholds specified in Annex I to the Regulation. EU estimates suggest that between 600 and 1,000 importers will be affected.

The Regulation also encourages Union importers to use so-called 'global responsible' smelters and refiners. These are companies located inside or outside the Union that are deemed to fulfil the requirements of the Regulation. Union importers that use such smelters and refiners, for example, do not need to follow certain audit requirements. The Commission will provide and regularly update a list of global responsible smelters and refiners whose supply chain due diligence practices have undergone an independent third-party audit.

Due diligence obligations

The Regulation provides for a six-step framework to follow: management system, risk assessment, risk response, audit, disclosure and report. The obligations range from substantive/operational to governance: Union importers must for example adopt a supply chain policy in accordance with the OECD Due Diligence Guidance for Responsible Supply Chains and establish a grievance mechanism, which would allow any interested party, including whistle-blowers, to voice concerns regarding the extraction, trade and handling of minerals in and export of minerals from conflict-affected and high-risk areas.

Deadline

Although the Regulation entered into force on 9 July 2017, the due diligence and transparency obligations begin on 1 January 2021, allowing companies time to establish compliant polices and processes. This may require adapting existing compliance and risk management systems, introducing new or expanded due diligence processes, contractual amendments and the establishment or adaptation of grievance mechanisms. If companies have not yet taken these measures it is now time to act, not least because it may take time to identify the relevant subsidiaries within a group, as well as their suppliers, and to ensure they comply.

International context

To ensure compliance with the Regulation, companies may build on their experience in the United States. Companies that issue securities on the US exchanges have been managing compliance with conflict mineral disclosure and diligence requirements since the US conflict minerals rule was adopted by the Securities and Exchange Commission ("SEC") in 2012 pursuant to the Dodd-Frank Act ("US Rule").

Like the EU Regulation, the US Rule applies to the 3TGs. The Rule requires companies for which conflict minerals are "necessary to the functionality or production of a product" to conduct a reasonable and good-faith inquiry to determine whether the minerals originated in the Democratic Republic of the Congo ("DRC") or an adjoining country. Hence, the territorial scope is narrower than that of the EU Regulation. Under the US Rule, companies must disclose any determination that minerals did not originate in the DRC or an adjoining country, or, where the inquiry determines that they did or that there is reason to believe they did, to exercise diligence on the source and chain of custody in accordance with a recognized framework, including in some circumstances obtaining an independent private sector audit. If the diligence confirms that the minerals originated in the DRC or an adjoining country, the company must file a Conflict Minerals Report describing the diligence and providing information about any products that have not been found to be "DRC conflict free"—i.e., that do not contain conflict minerals "that directly or indirectly finance or benefit armed groups" in the DRC or an adjoining country. The Report must include a description of the products, the facilities used to process the minerals, the country of origin of the minerals, and the efforts to determine the specific mine or location of origin.

The SEC may impose civil penalties for violations of the Rule. In 2017, however, the SEC's Division of Corporate Finance issued a statement that, due to court rulings that called into question the requirement that companies report and state on their websites that their products are not "DRC conflict free," it "will not recommend enforcement action" if companies only file disclosures under the first two parts of the Rule, which require the reasonable and good-faith inquiry and disclosure of any determination that the conflict minerals did not originate in the DRC or an adjoining country. However, this guidance is not binding on the Commission, which can still initiate enforcement action, and many companies continue to file Conflict Minerals Reports.

In summary, there are parallels between the EU Regulation and the US Rule. However, there are important differences, and companies that fall under both laws face the challenge of meeting disparate requirements.