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Germany’s ESG Law: A case study for new pharma pricing model
Pharmaceutical pricing is increasingly becoming a broader topic in the global push towards sustainability and environmental, social, and government (ESG) requirements, which cuts across corporate governance, the investment community, and global access to medicines. There are regular developments in requirements and standards in this space, and it forms a key component of the recently approved Supply Chain Due Diligence Act ( Lieferkettensorgfaltspflichtengesetz: LkSG) in Germany, which introduces new obligations for German companies with regard to protecting human rights in supply chains. The act also introduces obligations regarding environmental protection, in so far as this may be deemed necessary to protect human rights. The entire supply chain, from the extraction of raw materials to the delivery to customers, is covered by the LkSG. This act is the culmination of several years of growing pressure for action, with voluntary commitments proving to be insufficient. The requirements are internationally compatible and are based on the "due diligence standard" of the UN guiding principles. They will apply from 2023 for companies with at least 3,000 employees in Germany, and from 2024 for companies with at least 1,000 employees in Germany.
The new ESG requirements are dependent on the degree of influence a supplier has within the supply chain. Companies can only be punished for human rights abuses that they have been informed about, with no obligation to actually succeed in this effort. Although there are concerns that the act is relatively toothless, similar regulations being developed at a European Union level will be significantly more stringent in the enforcement of human rights protections across the supply chain. In February 2021, the European Commission kick-started a dialogue with the pharma industry related to safeguarding the security of the supply of medicines within the bloc. The initiative, which will continue throughout 2021, is expected to arrive at a set of policy recommendations, potentially involving ESG and human rights protections (including forced labor risks) within the context of global supply networks. Mandatory human rights and environmental due diligence of EU companies' global supply chains is also a key deliverable of the European Green Deal legislation that is in the process of being developed. It is possible that EU-wide legislation addressing human rights issues in supply chains will be forthcoming during the fourth quarter of 2021.
German pharmaceutical companies in favor of the ESG criteria extending across the supply chain
The German Medicines Manufacturers' Association (Bundesverband der Arzneimittel-Hersteller: BAH) supports the new Environmental Social, and Governance (ESG) law, although it has stated that many member companies have codes of conduct and contracts with suppliers that already follow the United Nations Guiding Principles on Business and Human Rights. The Federal Ministry of Labor and Social Affairs carried out a survey in 2020 looking at the protection of human rights along the value chain in key German industries and found that the pharmaceuticals and chemicals industries were comparatively advanced with regard to the implementation of human rights protections according to the German pharmaceutical journal Deutsche Apotheker Zeitung.
The introduction of ethical considerations into pharmaceutical supply contracts by statutory health insurance funds (Gesetzliche Krankenversicherung: GKV) has been gaining momentum. Last year, Germany's largest GKV, the Allegemeine Ortskrankenkassen (AOK), launched a tender for the supply of five antibiotics, as part of the discount contract system, which included a number of ESG conditions, including protections for workers' rights and environmental standards. More controversially though, the criteria also included a "closed-loop supply chain" within the EU to boost supply security. Unlike in previous discount contract tenders, the principle criteria was not the price — companies that had invested in higher environmental standards had a better opportunity to win the contracts. The AOK estimated at the time that these additional conditions result in a "bonus" for producers of up to 16%.
The antibiotic tenders were temporarily suspended earlier this year however after manufacturers successfully challenged the "closed-loop supply chain" criteria at the federal public procurement tribunal (Vergabekammer). The AOK fund is in turn challenging the tribunal's decision.
ESG criteria: A political strategy for supply security?
The new German law makes no geographical restrictions regarding the sourcing of raw materials but does require companies to ensure human rights and environmental standards are upheld globally across the entire supply chain. The government will undoubtedly face questions about potential changes to pharmaceutical pricing policies that would enable stronger ethical and environmental standards in supply chains, particularly given the additional costs typically involved with meeting ESG criteria.
In the context of the COVID-19 pandemic, and the increased risk of supply shortages due to reliance on Asian markets for cheaper medicines and active ingredients, there is likely now more political motivation than ever to apply strict ESG standards across all critical goods industries, including pharmaceuticals.
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