EU Proposal for a Directive on Corporate Sustainability Due Diligence: potential impact on businesses in Asia

The European Commission published, on 23 February 2022, its much-awaited Proposal for a Directive on Corporate Sustainability Due Diligence (the "Proposal"), aimed at imposing on companies of a certain size operating in the EU far-reaching due diligence obligations covering the adverse human rights and environmental impacts of their own operations, and those of their subsidiaries and their upstream and downstream value chain. For further information on the Proposal, see here.

In this blog post, we look at the potential impact of the Proposal on Asia-based businesses.

The Proposal does not provide for an import ban of products made by forced labour, including forced child labour (despite calls from the European Parliament that it be included). However, as set out in its Communication on Decent Work Worldwide (which was published alongside the Proposal), the Commission is preparing a separate proposal for this controversial topic which is expected to effectively ban products made by forced labour from entering the EU market, cover both domestic and imported products and include a robust, risk-based enforcement framework. We will wait to see how this will impact businesses in Asia.

Given the divergent views among Member States and EU institutions, the Proposal will likely be heavily negotiated before it is adopted. Member States will then have two (and, in relation to certain types of in-scope companies, four) years in which to transpose the Directive into national law, therefore, there is time to work out in more detail how the Proposal will impact businesses. There is a degree of uncertainty of how the Proposal will impact non-EU companies (and, in practice, all companies "in-scope") - there may be further clarifications and guidelines issued by the Commission in the future on these areas in the next phases of the legislative process. There are also some differences applied to the obligations on financial services companies which is intended to alleviate some of the regulatory burden.

Impact on companies incorporated outside the EU

Companies incorporated in the EU are “in-scope” provided they meet certain thresholds.

Non-EU companies

are also covered by the Proposal if they meet one of the two following thresholds:

• the company generates a net turnover of more than EUR 150 million in the EU market in the financial year preceding the last financial year; or
• the company generated a net turnover of more than EUR 40 million but not more than EUR 150 million in the EU internal market in the financial year preceding the last financial year, provided that at least 50% of its net worldwide turnover was generated in certain high-risk sectors. High risk sectors include the manufacture of textiles, leather and related products, and the wholesale trade of textiles, clothing and footwear, agriculture, forestry, fisheries, the manufacture of food products, and the wholesale trade of agricultural raw materials, live animals, wood, food, and beverages, as well as the extraction of mineral resources (regardless of where they are extracted), the manufacture of basic metal products, and the wholesale trade of mineral resources, basic and intermediate mineral products.

The Proposal will also, therefore, apply to non-EU companies active in the EU with a turnover threshold aligned with the above, generated in the EU. An Asia-based company that meets either of these thresholds will be an "in scope" company for the purposes of the Proposal.  

Human rights and environmental mandatory due diligence 

In summary, Asia-based companies that are “in-scope” because they meet the thresholds set out above would have to:

• integrate due diligence into their company policies and have in place a due diligence policy;
• identify actual or potential adverse human rights and environmental impacts;
• prevent or mitigate potential impacts;
• bring to an end or minimise actual impacts;
• establish and maintain a complaints procedure;
• monitor the effectiveness of the due diligence policy and measures; and
• publicly communicate what they are doing on due diligence.

For further details, see here.

These are far-reaching due diligence requirements which will apply in respect of a company's own operations, its subsidiaries and their value chains.

For companies in Asia that are not "in scope" but are part of the value chain of a company with an EU nexus, they will need to consider how the Proposal would indirectly affect them. For example, an Asia-based company which forms part of the supply chain of an "in scope" company may be required to:

• provide contractual assurances that they will comply with the "in scope" companies' code of conduct as part of the measures taken by the "in scope" company to prevent, cease, or minimise actual and potential adverse human rights and environmental impacts; or
• provide additional information on the human rights and environmental impact of their operations to the "in scope" company who is looking to pass on their new enhanced due diligence obligations onto upstream and downstream business relationships in their value chains, as well as monitor the effectiveness of the due diligence policy and measures. 

In the Q&A document published by the Commission alongside the Proposal, in respect of trading relationships with developing countries, it states that:

"the proposal also aims to address potential negative effects on trading partners in developing countries, which could include companies withdrawing from very risky territories if they cannot mitigate harm due to systemic issues. In this regard, the proposal contains accompanying measures, such as capacity-building support for SMEs with a view to mitigating such possible impacts. The aim is to make clear that companies should prioritise engagement with business relationships in the value chain, instead of disengaging, which should stay a last resort."

This will be one to watch for companies in Asia's emerging markets.

As a general comment, Asia-based companies will need to ensure they are engaging with business and human rights as a topic, including and especially at a senior board level and have the capability and capacity to comply with the requirements if they are "in scope" or with the indirect implications if they are part of the value chain of an "in scope" company.

The Proposal also includes a number of new obligations relating to corporate governance.

Climate change action plans 

In-scope companies (both EU and non-EU, but excluding companies covered by the Proposal only because they operate in the high-risk sectors identified above) are required to adopt a plan to ensure that the company's business model and strategy are compatible with the transition to a sustainable economy, including limiting global warming to 1.5°C in line with the Paris Agreement.

Based on information reasonably available to the company, this plan must, in particular, identify the extent to which climate change is a risk for, or an impact of, the company's operations. If this is the case (or the company ought to have reached this conclusion), the company must include emission reduction objectives in its plan.

If variable remuneration is linked to the contribution of a director to the company's business strategy and long-term interests and sustainability, companies should also take into account the fulfilment of these obligations when setting variable remuneration.

Directors' duties 

For directors of in-scope EU companies, they are responsible for putting in place and overseeing their companies' due diligence actions and policies and for adapting their companies' strategy accordingly. These requirements do not directly apply to non-EU companies. Therefore, whether directors of a company in Asia are required to take into account sustainability matters including the human rights, climate and environmental consequences in their decision-making, when fulfilling their duty to act in the best interest of the company, will continue to depend on the domestic laws in that jurisdiction, even if the Asia-based company is considered “in scope”.

However, on the question of directors' duties, a team of independent legal counsel at the Commonwealth Climate and Law Initiative ("CCLI"), commissioned a series of independent legal opinions on directors' responsibilities and climate change. The legal opinions issued in 2021 by CCLI in respect of Hong Kong, Singapore and Japan concluded that directors in each jurisdiction are obliged to consider climate risks in discharging their director's duties.

In Hong Kong and Singapore, the opinions concluded that directors are obliged to keep abreast of and manage relevant climate risks in discharging their common law and statutory duties to act with reasonable care, skill, and diligence and in the interests of the company. Key takeaways from CCLI’s Singapore publication are:

• all company directors must take into account ESG considerations in their decision-making;
• directors should seek to ensure that the companies on whose boards they sit develop ESG policies to provide frameworks for effective consideration of ESG factors in strategy-setting and decision-making;
• directors cannot claim ignorance of ESG issues; and
• failure to take account of ESG issues may constitute a breach of directors' statutory and common law duties.

In Japan, the CCLI found that directors could be in breach of Japan's Companies Act (and be held personally liable) if they fail to put in place a climate risk management system with sufficient capabilities to perform their responsibilities to oversee and manage climate-related financial risks and opportunities. Notably, where directors of Japanese companies lack climate-governance expertise (and that expertise is not available among the executives of the company), directors should look to hire outside professional expertise that can support their climate-related risk management decisions in the best interests of the company. 

Business and human rights in Asia

In the near term, the conversations in much of Asia will continue to focus on how non-Asian entities with supply chains in Asia can ensure that they are able to conduct comprehensive and robust due diligence to protect against the risk of corruption and / or modern slavery issues within these supply chains in light of European laws and, increasingly, investor and stakeholder scrutiny. This focus will be accentuated by the new Proposal discussed in this blog.  

Despite the lack of domestic legislation focusing specifically on human rights in Asia, companies with businesses in Asia will continue to be required to pay more attention to human rights and modern slavery issues in their own supply chains given the focus on these issues globally, and particularly where companies with global operations are complying with European laws in relation to due diligence.  

For more information on human rights due diligence in general, see our note and video series.