On 23 February 2022, the European Commission published a proposal that will require a large group of companies, to assess, monitor and report on sustainability issues. The focus on Environmental, Social and Governaing (ESG) factors in business continues to grow. The proposal includes obligations for companies to identify, prevent, end or reduce the negative impacts of their activities on human rights, such as child labour and worker exploitation, and on the environment, such as pollution and biodiversity loss.
Companies and their value chains play a vital role in building a sustainable economy and society. The proposal aims to promote sustainable and responsible business behaviour and to reduce negative impacts on human rights and the environment. The new proposal aims to create a level playing field for companies and consumers and to increase transparency for investors.
Scope of the directive
The Directive will apply to the following companies:
- European-based companies with more than 500 employees and a global net turnover of more than €150 million;
- European-based companies with more than 250 employees and a global net turnover of more than €40 million, where at least 50% is generated in sectors where a high risk of harm to human rights or the environment has been identified. This includes: textile industry, agriculture and mineral extraction;
- Companies based outside Europe with a net turnover of more than EUR 150 million in the European Union; and
- Non-European companies with a net turnover of more than EUR 40 million, of which at least 50% is generated in high-risk sectors.
Small and medium-sized companies (SMEs) do not fall directly within the scope of the proposal, however they will have to comply with the proposal if they supply companies covered by the directive on a structural basis.
What new obligations does the proposal impose on companies?
Companies falling within the scope of the proposed directive must take various measures as part of their corporate sustainability due diligence:
Identify potential negative impacts of activities
Companies must identify which activities fall within the due diligence requirements. The proposal applies to companies' own activities, but also to those of subsidiaries and associated value chains with which a company has an established business relationship. A relationship is considered an established business relationship if it is durable or expected to be durable and does not represent a negligible part of the value chain. This includes all related activities of established business relationships of an enterprise that are connected with the production of goods, the provision of services, the development, and the use and disposal of a product. The scope of the obligations is therefore very broad, as many companies operate within global and complex value chains. All companies in a company's value chain affected by the proposal will be indirectly affected by the obligations of the proposal.
Identifying and preventing or reducing actual and potential impacts
Companies must take measures to identify the possible actual and potential consequences of their actions. In doing so, it is important that companies make an action plan with all stakeholders. These include employees and other persons, groups or entities whose rights or interests are or may be affected by the products, services or activities of a company, a subsidiary or the established business relations. Once the adverse effects have been identified, companies must take adequate measures to prevent or mitigate the identified potential adverse effects. The proposal mentions, for example, a prevention plan, which can also be drawn up with the stakeholders. The adverse effects must be eliminated, and if this is not possible, they must be minimised by taking concrete measures.
Integrating due diligence into policy
Companies should integrate due diligence into corporate policies to mitigate adverse effects of activities.
Monitor the complaints procedure and its effectiveness
Companies should develop and maintain a complaints procedure to ensure that legitimate concerns about potential or actual adverse effects can be raised. This possibility must be offered to persons who are affected or have reasonable grounds to believe that they might be affected by the activities of a company. Companies should monitor the implementation and effectiveness of their due diligence measures by conducting periodic reviews.
Communicating externally on due diligence
Companies must provide relevant information on the due diligence, policies, processes and activities carried out to prevent actual or potential adverse effects, including the findings and results of the activities.
Obligations for directors
For directors, the proposal also entails a duty to set up and monitor the implementation of due diligence and to include it in the corporate strategy. In addition, in fulfilling their duty to act in the best interests of the company, directors must take into account climate change, human rights and the consequences of their decisions. The proposal therefore results in an increased duty of care for directors with regard to sustainability aspects.
European member states are required to designate governing bodies to monitor the new rules. These supervisory bodies can investigate, order the suspension of infringements, impose fines based on the turnover of the company and take interim measures to prevent damage.
The need for action: what can companies do now?
The impact of the proposal is expected to be significant. The proposal affects both large companies and companies in associated value chains. Companies should therefore start preparing themselves in order to integrate the above-mentioned obligations into the business plan and the business strategy. Processes and systems should be prepared to identify, monitor, prevent and reduce the negative impacts of activities on the environment and human rights throughout the value chain.
SMEs that are part of the value chains of large companies will be indirectly affected by the proposal. From large companies the need will arise to make contractual or non-contractual arrangements with SMEs concerning the new obligations. SMEs may therefore be obliged, via the large enterprises, to identify the consequences of their activities and to prevent and reduce these consequences. Therefore, SMEs must also prepare themselves to meet the new requirements and integrate them into their business plan and strategy. To support SMEs, Member States are encouraged to provide further tools such as platforms, portals or a financial contribution. In addition, large enterprises must apply fair, reasonable, proportionate and non-discriminatory requirements to SMEs and may need to support them (financially) in complying with the measures.
The proposal will now be discussed and the European Parliament and the European Council can still make changes. If the proposal is adopted, the Member States of the European Union will have two years to transpose the directive into national legislation. Therefore, it is not clear at the moment when companies will ultimately have to comply with the new obligations.
Van Doorne is happy to advise on environmental, social and governance issues and their integration into the business operations of companies. Van Doorne closely follows the latest developments.