Europe’s Due Diligence Rules Key to Sustainability Reporting

Despite the delay, the EC’s Sustainable Corporate Governance initiative is unlikely to be “watered down”.

The delayed EU Sustainable Corporate Governance initiative is the “missing piece” needed to ensure investors have decision-useful information on European companies’ environmental and social risks and impacts, according to Susanna Arus, EU Public Affairs Officer for law firm Frank Bold.

The initiative aims to create a European legal framework for corporate human rights and environmental due diligence, while also identifying how corporate governance can promote long-term sustainability-related action.

In combination with other reforms, the legislation would require companies to demonstrate they have identified, analysed and addressed risks to people and the environment as a direct result of business practices, both in its own operations and across the supply chain.

A proposal was due to be released in Q2 2021, but it was omitted from the raft of measures contained in the European Commission’s renewed Sustainable Finance Strategy.

Despite the delay, Arus emphasised that this “should not imply that [the initiative] will be watered down or mean that it isn’t going to be presented”.

It could actually be of benefit to the wider regulatory timeline for the Corporate Sustainability Reporting Directive (CSRD) and Sustainable Finance Disclosure Regulation (SFDR), said Arus. Nonetheless, to remain aligned with these incoming regulations, the initiative “needs to be presented in the Autumn without any further delay”, she warned.

An update to the Non-Financial Reporting Directive (NFRD), the CSRD outlines how companies should be reporting on their exposure to social and environmental opportunities and risks. Due diligence rules under the Sustainable Corporate Governance initiative would tell companies which issues need to be assessed and disclosed, such as human rights issues along their supply chains, Arus explained.

This will have a knock-on effect for asset managers complying with SFDR, which requires them to carry out due diligence on investee companies in order to accurately categorise their ESG-labelled products.

“For this, we also need companies to carry out their own due diligence and disclose the results of this process,” Arus told ESG Investor. “In turn, this would give investors the transparent information they need to inform their decisions and comply with their own obligations.”

Divergence on the details

The delay to the initiative came after a summary report on the public consultation outlined the divergence of opinion between NGOs and business representatives. It also received a negative assessment from the Commission’s Regulatory Scrutiny Board. The board advises the College of Commissioners on all proposed directives during the early stages of the legislative process.

Despite polarising opinions on the details, there is widespread support for the implementation of due diligence rules.

A group of NGOs responded to the delay, noting that more than 80% of respondents to the draft had expressed support for developing an EU legal framework for due diligence and harmonising due diligence requirements at an EU-level to “avoid fragmentation”.

Prior to this, in April 2020 a coalition of 105 investors managing US$5 trillion in assets called on governments to develop and enforce mandated due diligence requirements for companies.

This is because it is widely understood that sustainability considerations are not “properly incorporated into corporate strategies and the responsibilities of boards in this regard are not clear”, said Arus.

For example, only 14% of companies provide insights on the integration of sustainability in their core business strategies, board discussions and performance incentives, according to a recent study of 1,000 large EU companies’ non-financial sustainability reports by the Alliance for Corporate Transparency.

Further, the 2020 results of the World Benchmarking Alliance’s (WBA) Corporate Human Rights Benchmark showed that 104 of the 229 assessed companies had at least one allegation of a serious human rights impact that year.

It is expected that the Commission will formally adopt the initiative later this year.

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