In a previous article (published last April 25th) we saw that Canadian companies may face environmental compliance gaps when exporting to the old continent if they are not proactively adjusting to differences between European Union (EU) and Canadian environmental norms. As a result, some of our readers reacted with questions regarding the potential cost should a situation of non-compliance was discovered in the EU. Since this is a topic we encounter regularly we decided to answer it with a blog article.
At a first glance, the question might seem odd. After all, compliance with regulations is a minimum requirement to operate legally. It seems difficult (although unfortunately not impossible) to imagine a different scenario. One where non-compliance would knowingly go unaddressed and the potential financial losses of being uncovered would just be factored in as another operational cost. Of course, this would be un-ethical and would sooner or later turn out to be unsound for the business. Volkswagen scandal in 2016 serves as a reminder of that.
There are however unfortunate cases when companies step over the red line unwillingly. These events are more likely to happen, when, for instance, companies lack the capabilities to monitor fast evolving regulations and fail to implement new requirements at the operational level. Or, as it often occurs in the case of exports, they simply lack the internal know-how or the processes and staff required to effectively ensure that their products respect applicable norms abroad.
Whatever the reasons, companies will need to address gaps as soon as possible. In such situations, understanding the cost of non-compliance can help decision makers choose the most effective path forward and be prepared for the worst.
We provide below a few items to keep in mind when doing such cost assessment for exports to the EU.
Calculating non-compliance cost is not an exact science
Generally speaking, predicting how much it would cost a company’s bottom line if their products are found to be non-compliant is a difficult matter. The first reason is that it is often not a single cost, but rather a sum of multiple ones. Any combination of the below can happen:
- legal costs such as fines, attorney fees, courthouse fees or lawsuits.
- cost of litigation with your customers
- cost of “firefighting” such as addressing gaps in a short and often not cost effective timeline, mobilizing additional internal resources or fixing your public image
- cost of business disruptions such as missed opportunities, loss of market share, fees for delayed shipments or costs for storing undelivered goods
- cost of reputation loss with customers, the public and investors (this is a wild card and can make non-compliance costs spiral out of control)
The second reason is that the actual cost will usually depend on a variety of factors like the severity of the compliance gaps, the overall relationship the company or its customers have with the respective regulators, the skill set of the firm’s attorneys, the skill set of the auditors in identifying the deviations, the media coverage and the public reaction.
Specifics of the EU market with regards to environmental compliance and enforcement
The differences in regulation between EU countries increase the potential cost of non-compliance
In the EU, the implementation of environmental regulations, whether they are decided at national or at the EU level, is always done by each one of the member states. It means the exact interpretation, the severity of penalties and the level of enforcement (e.g. what kind of audits, how often, etc.) of a given regulation will vary significantly between countries. For instance, the graph below shows the maximum amount of fines (link) applicable across EU countries under the REACH regulation. Exporters into the EU are simultaneously exposing themselves to administrative or criminal fines in each country where non-compliant goods were shipped. The cost of non-compliance can becomes therefore significantly higher.
Level of administrative and criminal fines across EU countries
Source : Report on penalties applicable for infringements on the provisions of the REACH Regulation in the Member States published by the European Commission, Directorate General Environment, Chemicals Unit
Enforcement audits on imported goods are on the rise
In addition to regular audits, there are special audit (link) campaigns coordinated at the EU level, including verification of products received at customs. In one of the latest campaigns regarding the compliance with the REACH regulation, authorities found a high rate of non-compliance among imported goods. Authorities noted that the lack of compliance is often due to a lack of awareness and familiarity with obligations under the REACH Regulation. In their conclusions they recommend intensifying sanctions in case of repeated breaches of duties. Furthermore, the 2017 audit campaign is focusing on verifying the compliance of imported manufactured goods.
Beware of environmental clauses in your contracts
The companies receiving your goods in the EU (i.e. your customers) are the ones bearing, in most cases, the legal responsibility for any non-compliance of your products. As a result, EU companies are increasingly incorporating in their supply contracts specific clauses requesting suppliers to ensure products follow EU norms. In situations of non-compliance, non-EU suppliers that have such clauses in their contracts stand a higher risk of being pursued in courts by their EU customers.
The likelihood of products lagging behind norms is higher due to ever-evolving regulations
EU environmental requirements are often more aggressive and evolve at a more rapid pace than in other jurisdictions. For instance the REACH Candidate List, a list of chemicals that must be declared to customers if found in manufactured goods, is updated every 6 months and immediately enters into force. In all, there are half a dozen such lists that need to be monitored, understood and complied with. In a nut shell, there are more opportunities for missing things therefore higher chances of encountering compliance gaps.
Not complying with chemical restrictions and prohibitions is a show stopper
Besides penalties and fines, there have also been instances when authorities have decided to forbid the selling of products found to be non-compliant and even order the recall of already sold items. Such measures are more likely to be taken when products contain illegal quantities of restricted or prohibited substances. Historically, the financial implications of such measures have been significant and in many cases affected the reputation of a company with the public, their customers and the investor community.
For instance the Japanese company Sony had to replace components for 1.3 million PlayStation One game consoles (link) after the Dutch government blocked sales of the machines because they contained a restricted substances above legal thresholds. According to a United Nations Agency’s estimates this led to around 150 million US dollars in losses. In the aftermath of this event, Sony resolved to implement an environmental compliance management system targeting its supply chain.
What does this mean for Canadian exporters?
If you are already exporting goods to the old continent or thinking of doing so now that CETA (view article) is approved, but no one in your company has ever heard of legislation such as REACH, Biocides Regulation, CE marking or RoHS, than chances are you are exposing yourself and your EU customers to environmental non-compliance risks. Why?
Environmental norms continue to evolve in the EU in a different and usually more aggressive way than those in Canada. This increases the likelihood of compliance gaps accumulating unknowingly. At the same time, EU authorities increase their enforcement activities for imported goods. Therefore non-compliance risks could materialize at a faster pace than in the past.
From experience, we know that even long time, experienced exporters to the EU struggle sometimes to keep up with the ever-evolving regulatory landscape. But this is even more the case for small and medium enterprises since they are usually less aware and less well equipped to manage environmental risks beyond their four walls.
As seen above, the impact of non-compliance has the potential of being high both for Canadian exporters and for their customers in the EU. Companies not well prepared may be exposed to business disruption, legal or reputational risks, affecting their bottom line and making them potentially less competitive then their EU counterparts.
On the positive side, implementing relatively small proactive measures and best practices can reduce compliance risks significantly. Companies adopting such behaviors have shown they are able to take timely actions and successfully protect their market share. Bellow, an example close to home:
In 2008, some of the flagship pigments that the Dominion Colour Corporation (DCC) of Canada was selling on the EU market were scheduled for restriction there as of 2015. DCC realized early that the only way to continue supplying its pigments was to obtain an authorization from EU authorities. In a strategic move, the company decided to pursue this avenue and hired specialized external help. Being pro active, DCC had enough time to provide to authorities the vast amounts of data required to be collected internally and from their EU value chain. In addition, DCC managed to respond to more than 380 comments (watch video) received from non-governmental organizations (NGOs) and competition who were arguing that safer alternatives existed. The effort paid off as DCC eventually obtained an authorization in time to avoid business disruption. For the next 3 to 6 years it became the only supplier allowed to sell these substances in the EU. Had they been less well prepared the story is sure to have been different.
Conclusion
The actual cost of non-compliance will depend on a variety of factors and remain generally difficult to predict quantitatively. What is clear is that due to its specifics, the EU market is challenging from an environmental regulations stance and the cost of non-compliance is potentially very high when Canadian exporters are not well prepared. If you are at a point where you wonder about non-compliance costs, there are good chances you need some help to better adapt to EU environmental requirements.
In practice, companies will benefit tremendously if they get prepared by monitoring regulatory changes and understanding which ones apply,
ensuring more and better traceability of the chemicals that are present in their products and their value chain, identifying supply disruption or obsolescence risks caused by substances targeted for phase-out being in a position where they can quickly estimate environmental impacts over the life cycle of their product.
By doing so companies will manage to proactively mitigate the risks and costs associated with achieving compliance.
At Carbon Consult Group we believe the adjustment to European environmental legislation can be achieved in a cost effective way and can deliver new business opportunities largely outweighing the initial investments. The main criterion for success is that it is done in a timely manner and with the right level of help and expertise.