On Wednesday 23 February, the European Commission proposed its long-awaited corporate sustainability due diligence proposal with the aim of ensuring sustainable company operations and value chains in terms of their impact on the environment and human rights. The proposal has been a topic of debate in the stakeholder community and faced multiple delays. In this post we discuss its potential impact on the private sector.
The issue
With today’s globalised world, supply chains have grown on an international level resulting in increasing prosperity around the globe. In some instances, however, globalization also resulted in negative impacts ranging from labour rights violations to environmental damage. To address these situations, multinational companies and corporations have been encouraged to increase their role in the protection of human rights and the environment alike.
From a European perspective, the European Commission’s Green Deal ambitions put the topic of due diligence in the supply chain on the European agenda. In 2020, the Commission already published a study on due diligence, as well as one on director’s duties.
Why this proposal?
In order to lead the way towards higher human rights environmental standards, the European Commission decided to publish a new proposal for a Directive which, if adopted, would introduce a mandatory baseline for liability with respect to sustainability and good conduct. The initiative relies upon an already existing international framework that is characterized by different codes of conducts such as the United Nations Guiding Principles on Business and Human Rights, the International Labour Organization’s Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy, and the OECD Guidelines for Multinational Enterprises. But while these codes are all calling for actions, it is only on a voluntary basis, which is deemed insufficient by the Commission. In addition to that, some EU Member states such as France and Germany, who already implemented a national due diligence plan, have been strongly supporting the implementation of a mandatory approach.
As a result, companies operating within the European Union and falling within the criteria established by the proposal will, once adopted, have to comply with due diligence requirements which encompass human rights and environmental convention which add up to the requirements provided by other legislations such as taxonomy, corporate reporting standards and sustainable finance principles. The legislative proposal aims to integrate sustainability practices into long-term business strategies, and into decisions delivered to meet growing investors’ expectations on companies regarding sustainability. Linked to the Green Deal as a central component of sustainability, the proposed Directive will aim to level the playing field for all companies operating in the EU market, increasing legal clarity, and establishing an effective enforcement mechanism. Additionally, it will push stakeholders to take into consideration business operations’ impact on the environment, society, human aspects, and the economy.
Who is in scope?
Companies located or operating in the EU with more than 500 employees on average and a net worldwide turnover of more than EUR 150 million are covered by the legislation. The measures presented in this initiative will therefore have an extraterritorial outreach. For companies with part of their turnover stemming from certain high-risk sectors, such as the extraction of mineral resources, other thresholds apply. The thresholds mean that around 99% of European businesses (comprised of SMEs) will be excluded from the scope of the legislation. However, according to an estimation from the European Commission, the Directive will still cover around 13,000 companies operating in the EU and 4,000 outside of the EU.
What is included in the measures?
If the proposal is adopted as it is, the companies in scope will have to implement environmental and human rights due diligence measures to identify actual or potential adverse effects from their own operations or in their supply chain, and prevent these effects where possible. When such adverse impacts are existent, they should be minimised or mitigated and when damages are reported, they will require a matching compensation. Companies should also ensure that their business model and strategy is compatible with the targets set out in the Paris Agreement.
Additionally, company directors will play an important role with a duty of care. This means that they need to consider the impact of their decisions. Directors should also include a plan to ensure that the business model and strategy of the company are compatible with the sustainable transition, and oversee due diligence actions.
What is the impact on the private sector?
Above all, it is important to underline that the Directive (once adopted), will need to be implemented through national legislation – hence leaving room for interpretation in the different Member States, meaning that the compliance assessment and the sanctions will vary from one jurisdiction to another. In addition, smaller companies who would initially not fall within the scope of the legislation will also be indirectly affected should they be involved in the supply chain of a business impacted by the Directive.
While most large corporations have already implemented different strategies and measures relating to sustainable corporate governance and social responsibility, this Directive drifts away from voluntary measures and will entail more stringent rules. This means that companies falling within the scope of the Directive will need to establish internal processes to assess their own business activities, as well of their partners active in the same value chain.
Ensuring compliance with these measures will require investments, but that will be lower in contrast with adverse impacts to the environment and/or human rights that would otherwise occur. Also, the proposal outlines a limited number of sanctions that should apply in all Member States but leaves it to the Member States to ensure a proportionate enforcement process, in line with their national law. When pecuniary sanctions are imposed, they shall be based on the company’s turnover to ensure their proportionate level. Lastly, Member States shall ensure that companies applying for public support certify that no sanctions have been imposed on them for a failure to comply with the obligations of the proposed Directive.
What are the next steps?
Now that the proposal has been presented, it will be up to the European Parliament and Council of the EU as co-legislators to establish a position on the file in line with the ordinary legislative procedure. Together, they will have to come to an agreement on the final text of the file. In the European Parliament, Member of European Parliament Lara Wolters (S&D, NL) will lead on the file in the Legal Affairs Committee. In the Council of the European Union, the Working Party on Company Law (a preparatory body) deals with the proposal. Once adopted, Member States will have two years to transpose the Directive into national law and communicate the relevant texts to the Commission.
Recommendations
Given that the proposal is looking to create a new sustainability paradigm in which the private sector will be strongly involved, we would suggest considering the following actions to facilitate the transition to the new standards and guidelines:
- Determine the proposed legislation’s impact on your business.
- Communicate your positions on the proposal, complemented by solid evidence and data, to the policymakers involved in the legislative process.
- Assess the extent to which due diligence policies are already present in your company.
- Assess the prevention mechanism processes that have been implemented. Consider working on a preliminary draft process in the event that no prevention mechanism has been implemented so far.
- If not already set, establish a baseline to track sustainability progress against, and put in place key sustainability performance indicators.
- Undertake a thorough risk assessment of the company’s supply chain.
- Communicate the efforts made by the company in this area to the investors and wider public.
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