Limited scope and enforcement undermine proposal’s ability to mitigate environmental and human rights risks, experts say.
Much-anticipated proposals for an EU directive on corporate sustainability due diligence will have limited impact, according to lawyers and NGOs.
The proposal aims to ensure European companies identify and mitigate the adverse impacts of their activities on human rights and the environment across their supply chains.
However, since plans for the directive were originally announced, “the proposal has lost its ambition”, according to the World Wide Fund for Nature (WWF). This was a concern initially highlighted by industry experts following delays to the proposal last year.
“What’s more, the directive’s name has been changed from Sustainable Corporate Governance to Sustainable Corporate Due Diligence, which reflects the fact that its focus has been reduced,” the NGO noted.
It had been hoped that the legislative proposal would improve investors’ oversight of the environmental and social risks in their portfolios. Last month, more than 100 companies, investors and business associations told the commission its proposals should embed requirements in appropriate governance structures such as corporate boards and introduce credible accountability mechanisms.
As unveiled yesterday, the proposed legislation will apply along the full value chains of EU and non-EU companies in the single market with more than 500 employees and revenues of at least €150 million. In high-risk industries, such as oil and gas and agriculture, companies with more than 250 employees and €40 million annual revenues will qualify.
In-scope companies must integrate environmental and human rights due diligence into their internal policies, monitor the effectiveness of these policies, establish and maintain a complaints procedure, and publicly disclose their due diligence progress. Corporate directors will be responsible for setting up and overseeing the implementation of these processes, but their duties will be enforced by Member States rather than centrally.
The former group of qualifying companies will also be required to disclose how their business strategy aligns with the Paris Agreement’s target of limiting global warming to 1.5°C.
Clotilde Henriot, Trade and Environment Lead at environmental law group ClientEarth, noted this “could be a much-needed driver of corporate climate action”.
The proposal will now be presented to the European Parliament and Council for approval. Once adopted, the Member States will have two years to transpose it into existing national laws, which will need to be implemented if they do not already have laws in place.
Directors’ duck responsibility
The European Commission should charge directors with the responsibility of enforcing proposed due diligence rules, as opposed to Member States, according to Julia Otten, Policy Officer at law firm Frank Bold.
“We welcome the specification of the directors’ duty of care, but it is essential that directors are clearly responsible for the approval of strategies that react to problems. The Commission should not leave this up to national law,” she said.
The WWF said it is “particularly alarmed that director’s obligations are so vague”.
In particular, the NGO cites concern that there is no mandatory obligation to ensure directors’ variable remuneration is linked to their contributions to companies’ sustainability efforts.
Frank Bold’s Otten also raised concerns that the proposal potentially allows firms to comply by making relatively minor changes to their practices, rather than integrating environmental and human rights due diligence more deeply into their business models and strategies.
“One that we find very problematic, is that for fulfilling the preventive due diligence obligation companies can rely on clauses of contract. There is a risk in creating a tick-the-box exercise,” she said, calling for this fallback option to be removed in favour of strengthened preventive action plans.
Some observers asserted that the proposal’s requirements of directors have been weakened by lobbying efforts.
“We deeply regret that the Commission surrendered on the issue of directors’ obligations to the pressure of conservative corporate lobbies and the Danish, Swedish and Finnish governments, among others,” said Julia Linares Sabater, Senior Sustainable Finance Policy Officer at WWF European Policy Office.
The EU’s Taxonomy Regulation has also been subject to lobbying efforts by gas companies, which many believe has contributed to the inclusion of gas through a complementary delegated act.
Concerns have been raised that the scope is too focused on Europe’s largest companies, with potentially limited impact on the region’s small- and medium-sized enterprises (SMEs).
“Currently it will only apply to around 1% of EU companies because 99% of businesses in the EU are SMEs,” said Guillaume Croisant, Managing Associate at law firm Linklaters.
However, Croisant acknowledges that the complexities and costs surrounding the proposal would make it more challenging for SMEs to comply.
The European Commission said that, while SMEs do not fall under scope, they may be indirectly affected by the new rules as a result of large companies’ actions across their value chains.
“The proposal foresees specific support addressed to SMEs, such as guidance and other tools to help them gradually integrate sustainability considerations in their business operations,” the Commission said. “Member States shall provide further technical support, and may provide financial support to SMEs to facilitate adaptation.”
The directive will also include elements to protect SMEs from excessive requirements from in-scope large companies, the Commission added.
“Non-EU companies will also be exposed to the EU initiative through business relationships with EU companies in scope, as large companies are expected to pass on demands to their suppliers and other business partners,” said Croisant.
Room for improvement
The proposal’s next steps for approval by member states and MEPs means there is scope both for toughening up the draft proposal and further dilution if its provisions. There are a number of factors the law must include if it’s to be effective, according to the non-profit Business and Human Rights Resource Centre.
These include ensuring a strong civil liability regime providing access to justice and remedy for harms, encouraging effective stakeholder engagement, introducing mandatory requirements beyond tick box exercises and auditing, and supporting all internally recognised human rights and environmental standards.
“With these rules, we want to stand up for human rights and lead the green transition,” said Didier Reynders, EU Commissioner for Justice. “We can no longer turn a blind eye on what happens down our value chains. We need a shift in our economic model. The momentum in the market has been building in support of this initiative, with consumers pushing for more sustainable products. I am confident that many business leaders will support this cause.”