Due Diligence May Remain ‘Flexible Concept’ Under EU Proposal

Investor liability over supply chains of investee companies to increase.

Corporate due diligence is likely to remain a “very flexible concept” under a new European proposal requiring firms to conduct rigorous checks on human rights and environmental issues along their supply chains.

According to Filip Gregor, Head of the Responsible Companies Section at non-profit and purpose driven law firm Frank Bold, due diligence is “not limited to causation”.

“You, as a company may be linked to a problem without necessarily causing it and still you have certain responsibilities in this regard,” he told ESG Investor.

The planned EU-wide mandatory human rights and environmental due diligence law will seek to specify for all companies, including asset managers, due diligence processes and establishes the rights of individuals to hold firms liable for non-compliance.

“The main purpose of the legislation is to protect human rights and the environment, and those people who are affected by human rights violations,” explained Gregor.

The European Parliament passed a vote on the legislative initiative earlier in March. And the European Commission is expected to table a sustainable corporate governance directive by June 2021.

It would apply to large undertakings governed by EU law or established in the territory of the Union, as well as publicly listed and high-risk small and medium-sized firms. This includes firms operating in high-risk sectors, which are governed by the law of a third country when they operate in the internal market selling goods or providing services.

The regulation would create coherence with existing sustainable finance regulation.

To protect human rights and the environment, the law seeks to set up minimum safeguards by requiring companies to carry out diligence processes for their value chains.

Operationalising human rights law

The EU Taxonomy regulation and the Sustainable Finance Disclosure Regulation (SFDR) already outline the need for due diligence processes.

Based on existing OECD guidelines, the proposed law seeks to clarify and define how to carry out existing due diligence requirements through specific criteria, Gregor said.

“For financial products to be labelled sustainable, [they] must be supported by minimum safeguards that they are not related to the risks of severe adverse impacts across the value chain linked to the products or activities,” he explained.

Companies will need to upload their due diligence strategy or the statement including a risk assessment publicly and on a European centralised platform, a report by the European Parliament said.

The draft directive also requires companies to consult with relevant stakeholders.

“The consultation and involvement of [all relevant] stakeholders can help undertakings to identify potential and actual adverse impacts more precisely and to set up a more effective due diligence strategy. This Directive therefore requires the discussion with and involvement of stakeholders at all stages of the due diligence process,” the parliament report said.

No black and white liability claims

The financial risks to hold companies liable along their supply chains will become very real under the new law, said Gregor, but the liability of investors – for contributing to harm through, for example, capital allocations – will only increase to a certain degree.

“The stronger the involvement and influence of the financial actor over the harmful operation, the bigger is the likelihood of liability,” he said.

For example, direct investments in polluting projects may be seen as contributing to harm if no due diligence was carried out, Gregor notes.

But companies shall not be held liable if they can prove that they took all due care to avoid the loss or damage, or that the damage would have occurred even if all due care had been taken, the parliament report writes.

Gregor also explained that, while due diligence is a flexible concept, the “very fact that you relate to it doesn’t necessarily mean you are responsible all the time; [it depends] on the context”.

“There’s never going to be a black and white checklist for the public authorities,” he believes.

Gregor recommends investors in companies with high-risk supply chains to ensure that these have a robust due diligence system in place.

This includes identifying risks, setting relevant targets to prevent or mitigate issues and tracking the effectiveness of the measures taken.

During all stages of this process, he said, it is important for companies to get “input from the people who are affected by those salient issues”.

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