Whilst geopolitics have taken centre stage in 2022, the beginning of the year also saw a significant development in the business world, as the European Commission published the long-awaited proposal for a Directive on Corporate Sustainability Due Diligence.

Originally a proposal for a Directive on Sustainable Corporate Governance, it was expected to be published in June 2021 but was delayed by the Commissions’ Regulatory Scrutiny Board and, rather than providing general governance rules, the corporate due diligence duty is focused on ending, preventing and accounting for the negative human rights and environmental impacts of a company’s operations, including across its subsidiaries and value chains.

The latter point is key, as global ESG and sustainability partner at Ashurst, Anna-Marie Slot, explains: ‘What it’s trying to do is to get European companies to look down the value chain, which is a bit wider than your supply chain.’ This value chain covers the broad spectrum of a company’s production, marketing and after-sales services, compelling it to work with its established business relationships to ensure compliance across the chain.

‘You have to adopt certain policies and codes of conduct that you make sure people in your value chain are also following, then you have to check on it’, says Slot. ‘Conceptually the law is building on UN and OECD principles that are already out there about corporate responsibility and human rights.

Why was it needed? 

Businesses play a key role in creating sustainable and fair economies and societies, however, the increasing complexity and global nature of supply chains creates challenges for companies to get reliable information on suppliers’ operations. The fragmentation of national rules on corporate, sustainability-related due diligence obligations further hampers the drive for good practices. Stand-alone measures by some EU member states are no longer enough to encourage and assist multinational companies with acting sustainably, particularly across their global value chains. 

In order to begin addressing these issues, under the proposed directive companies ‘must do due diligence to identify what might be happening in that value chain which would negatively impact human rights or the environment’, says Slot, pointing out that the proposed directive ‘mandates companies to undertake due diligence around human rights in a way that hasn’t been mandated before.’ 

How does climate change fit into the proposal? 

Another core consideration of the directive is how it interacts with the ever-increasing importance of climate change in corporate policy. Environmental impact is a big part of the proposal, with the EU increasingly looking for ways to transpose ESG goals and trends from the private sector into law.  

Large companies affected by the proposed directive must plan to ensure their business strategy is compatible with the 1.5°C global warming goals set out in the Paris Agreement. Under the directive, directors are incentivised to contribute to sustainability and climate change goals and a company’s plan must identify the extent to which its activities impact, or risk impacting, climate change. 

‘You are seeing climate risk being forced more and more on to the corporate agenda’, says Slot. The directive aims to increase the pressure in this area, something Slot suggests the EU is committed to following through on: ‘I think the EU is very dedicated to progressing its sustainable goals; that is very high on their agenda and absent some big change in EU leadership, I think there will be a lot of pressure for the member states to implement it.’ 

Who is affected by it and how will it be enforced? 

The directive is aimed at large EU limited liability companies which are broken down into two main groups: Group 1 includes companies of 500 plus employees and a net turnover of more than €150m worldwide; group 2 includes companies with more than 250 employees and a net turnover of €40m worldwide, as well as companies operating in high impact sectors such as textiles, agriculture, and extraction of minerals. 

For companies in group 2 the new rules will start to apply two years later than for those in group 1. Also affected are third country companies active in the EU with a turnover threshold generated in the EU and aligned with either of these groups. 

These companies will be compelled to comply by a combination of administrative enforcement and civil liability. With this two-pronged approach compliance will be supervised by EU member states which have to designate an authority to ensure effective enforcement, and EU member states will hold companies liable for damages if they fail to comply with the due diligence requirements. 

Where a fault is found, states can impose fines or issue orders requiring a company to comply their obligations. In addition, the proposal includes an extension of directories’ duties, requiring directors to incorporate sustainability matters into their decision-making as part of their directors’ duty of care. 

On the face of it, this is a positive move affecting a broad range of multinational companies within the EU, with potentially significant repercussions should they fail to comply. However, it remains to be seen how effective this enforcement will be and what version of the directive comes out of the legislative process. 

As Slot notes, ‘there’s a lot of challenges; there’s the objective of the law and the implementation of the law, and then there’s how it actually works out in practice.’ 

Possible stumbling blocks 

One of the principal hurdles to the success of the directive could be where it comes into conflict with competition law. This is a concern of Anna Kuusniemi-Laine, head of sustainability at Castrén & Snellman Attorneys: ‘The corporate sustainability directive itself will not be sufficient, because it doesn’t offer cooperation tools; it says that companies need to cooperate, but that refers to competition law.’ 

Herein lies the contradiction, as states and regulators are not famously comfortable with too much inter-company cooperation. 

‘If we think about agreements where companies would, together, agree to pay attention to minimum working conditions in the developing countries or agree on minimum wages etc, it’s possible that that would be treated as a competition law violation’, says Kuusniemi-Laine, who sees this as ‘one of the most urgent things that should be corrected [in the proposed directive], because if companies on the one hand are told that they need to cooperate, and then on the other there’s a message that if you cooperate we investigate this as a cartel, then this whole thing doesn’t work.’ 

Slot shares some of these competition law concerns: ‘If you’re creating an industry standard, you necessarily have to be speaking amongst the industry, and that always gives rise to concerns that in fact you’re not talking about standards, you’re using it as an opportunity to collude.’ 

So what is the solution to this competition law catch-22? 

‘I think it’s not sufficient if we just have this corporate sustainability due diligence directive, because in practice there are issues where companies need to cooperate, and the competition rules should allow this kind of cooperation’, says Kuusniemi-Laine. 

Fortunately, for the possible success of the directive, discussions are underway with the EU Commission on ways the laws and competition rules could be changed to mitigate this contradiction, the aim being, as Kuusniemi-Laine suggests, ‘to allow more cooperation between competitors and to really allow faster and more progressive development, both in terms of the fight against climate change and also in human rights issues.’ 

While some wrestle with the sticky competition law aspects of the directive, another potential hurdle is the legislative process itself. The proposed directive is currently undergoing the EU legislative process and is not expected to be adopted before 2023. Once adopted, EU Member States will have two years to transpose it into national law. 

This process will be far from clear sailing. As Slot suggests, ‘bear in mind that what’s going to happen to this draft is that it has to go through each country’s processes, so it’ll probably be another year before it actually gets reflected in countries’ laws.’ 

Cautious optimism 

Despite these challenges, the proposal is widely seen as a positive move from the EU commission. 

‘I think it’s a big step forward’, says Kuusniemi-Laine, ‘but it’s not sufficient in itself; there are other measures that need to be taken as well’. 

If these other measures can tackle some of the competition law and supply chain issues arising from the proposal, and then navigate the tricky legislative process, then there is optimism that the directive on corporate sustainability can achieve some of its goals. 

Stumbling blocks aside, at its core the directive aims to create a more accountable, responsible and sustainable business world, and whether or not it succeeds in this lofty pursuit, as Slot point out, ‘to the extent that you are driving people into doing due diligence and being transparent, those are never bad things for a functioning market.’