A new approach to corporate governance?

In October 2020, the European Commission launched a consultation on sustainable corporate governance. The consultation closes on 8 February 2021 and a draft legislative proposal is expected in Q2 2021.

Heavily influenced by studies which suggest companies performing well on sustainability factors outperform their peers and are more competitive, the Commission believes it is important for sustainability to be further embedded into corporate governance frameworks. This includes encouraging businesses to consider the environmental (e.g. climate and biodiversity), social, human and economic impacts of their business decisions, and to focus on long-term sustainable value creation rather than taking a short-termist approach focussed on value creation for shareholders.

The Commission is therefore consulting on a possible new mandatory due diligence regime aimed at ensuring undertakings are aware of their impacts on the environment and human rights, amongst other things. This follows calls from a number of prominent EU-based companies who believe such an initiative would level the playing field in this area, and ensure harmonisation of approaches.

The Commission is seeking views on five potential approaches but notes that all are meant to build on existing standards, such as the OECD Due Diligence Guidance for Responsible Business Conduct or the UN Guiding Principles on Business and Human Rights (UNGPs) – “soft” laws which have paved the way for what “good” looks like in this area. Options range from a “principles-based” approach comprising a general due diligence duty, to more prescriptive approaches including minimum process standards. Also under consideration are approaches applicable to key sectors only, or extending only to specific areas such as child labour.

The Commission also asks whether any such requirements should apply also to non-EU companies carrying on business in the EU and how they should be enforced (by third parties in court, or subject to regulatory oversight with effective sanctions).

The Commission also raises a number of other questions which seek to explore other aspects of sustainable corporate governance. A number of these are focussed on how directors’ duties should be understood and interpreted against the evolving ESG landscape. For example, whether sustainability risks, impacts and opportunities should be integrated into the company's strategy, decisions and internal oversight functions, whether a more diverse range of stakeholder interests should be taken into account, and whether directors should be required to set up adequate procedures and where relevant, measurable (science-based) targets, to ensure that possible risks and adverse impacts on stakeholders are identified, prevented and addressed. Other questions focus on directors’ remuneration and incentives.

A robust new approach?

In September 2020, the European Parliament’s Committee on Legal Affairs published a draft report with recommendations to the Commission on what it believes should be included in the Commission’s proposal in relation to due diligence. Although not binding on the Commission, the Parliament’s recommendations provide interesting food for thought on what might, eventually, be included in the Commission’s legislative proposal and have been the subject of much discussion at EU level.

The report recommends a broad approach which would cover all undertakings selling goods or providing services in the EU. It contemplates a requirement to undertake a risk assessment on whether the undertaking’s operations and business relationships cause or contribute to human rights, environmental or governance risks, and if they do, to prepare, consult on and publish a due diligence strategy. Their expectation is that proportionate value chain due diligence would be undertaken, and that tools (such as supplier contract terms) would be deployed to support this. A grievance mechanism meeting UNGP criteria would need to be established.

Perhaps most importantly, the recommendation makes clear that undertakings would be expected to remedy adverse impacts they cause or contribute to, closely mirroring the expectations set in the UNGPs and that undertakings could be held to account by affected persons in European courts. Regulatory authorities would also have sweeping powers of enforcement.

Clearly, the Parliament is pulling no punches with its recommendations. The message is clear: existing voluntary due diligence standards have not delivered the desired result; what is needed is a tough, all-encompassing mandatory regime with real teeth.

What to look out for

The Commission’s consultation closes on 8 February 2021 and a draft legislative proposal is expected in Q2 2021.

Although it is still too early to tell exactly what will be included in the legislative proposal, the Commission has previously indicated that it is committed to making human rights due diligence mandatory. The Council has also called on the Commission to launch an Action Plan by 2021 focusing on shaping global supply chains sustainably, promoting human rights, social and environmental due diligence standards and transparency, in addition to tabling a proposal for an EU legal framework on sustainable corporate governance including cross-sector corporate due diligence obligations along global supply chains.

The EU are not the only ones considering next steps on human rights due diligence. In a separate development, the referendum on the Swiss Responsible Business Initiative failed in November 2020 but there are still plans to roll out a more limited law in Switzerland that would require due diligence in respect of conflict minerals and child labour. For more information, see our blog post: Swiss Responsible Business Initiative defeated.