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Sustainable Corporate Governance Reforms & Supply Chain Due Diligence: The European Commission’s Green Deal Meets Human Rights Legislation

January 14, 2021, Covington Alert

This year will see the European Commission put forward legislative proposals on mandatory human rights and environmental supply chain due diligence as well as on sustainable corporate governance (“SCG”). The EU’s Justice Commissioner, Didier Reynders, confirmed this timeline when launching a public consultation on how the Commission should approach this legislation.

These legislative proposals crystallize the European Commission’s efforts to make Europe a trailblazer for requiring companies to integrate considerations of sustainability, human rights and environmental impacts into their everyday business practices. Commissioner Reynders had previously stated that these proposals will not only apply to companies established in the EU, but to all companies doing business in the EU – one of the world’s largest markets. This legislation will therefore have significant ramifications for companies across the globe, which will need to comply with the obligations set down in the proposals if they wish to continue operating in the bloc.

The European Commission’s consultation is an important opportunity to contribute to legislation that may have significant and long-lasting effects on how companies are organized internally, and in their supply chains. Companies can submit their feedback online until February 8, 2021.

Views From the Member States and the European Parliament

Key EU stakeholders have already opined on the upcoming legislative proposals.

Shape of the Proposals

At a recent meeting with Members of the European Parliament (“MEPs”), Justice Commissioner Reynders suggested that the Commission may present its SCG proposal – which focuses on extending corporate directors’ duties to stakeholders other than shareholders – alongside the its proposals for mandatory human rights and environmental due diligence, calling the proposals as “one initiative with two bars”. This suggests that the Commission may present the proposals as a package, as it did previously with the New Deal for Consumers. Taken together, these proposals will seek to put the EU’s thinking on “stakeholder capitalism” into practice.

The Commission’s agenda on mandatory human rights and environmental due diligence has received significant attention in recent months. As we reported in April, following the publication of a study on due diligence requirements through the supply chain, Commissioner Reynders made the landmark commitment to legislate so that human rights and environmental due diligence will become mandatory for companies operating in the EU.

In July, the Commission published a further study on Directors’ Duties and Sustainable Corporate Governance. Like the study on due diligence, the work on directors’ duties has its political origins in a 2018 Commission Action Plan, but its focus is wider and encompasses core corporate governance questions. These include strengthening directors’ duties to integrate long-term interests and sustainability risks, impacts, opportunities and dependencies into the overall strategy of the company. They also extend to issues such as the diversity of board memberships, remuneration, and share buy-backs.

While addressing both agendas, the public consultation maintains the delineation between supply chain due diligence and proposals for corporate governance reforms.

Sustainable Corporate Governance Proposals

The Commission’s consultation encompasses three issues of core corporate governance.

  • Directors’ duties: The Commission is seeking input on redefining directors’ duties of care. This includes requiring directors to consider and balance the interests of a broader range of stakeholders with the short-term financial interests of shareholders. The consultation entertains a new requirement for directors to consider the environmental, human rights and social impacts of their activities, and to integrate sustainability risks, impacts, and opportunities into the company’s strategy. Adequate procedures and measurable targets may become mandatory to ensure stakeholder risk and impact are identified, prevented, and addressed. Notably, the Consultation asks whether stakeholders (e.g., employees, environmental agencies, or people affected by operations of the company as represented by civil society) should be given a role in the enforcement of directors’ duty of care.
  • Remuneration of directors: The Commission is consulting on different approaches to aligning directors’ remuneration with a longer-term perspective. The consultation mentions the integration of sustainability risks and opportunities in business strategies, and the establishment of sustainability-related metrics in remuneration schemes, which might be linked to the company’s sustainability targets or performance. Other potential measures include: (1) a requirement to include carbon emission reductions, where applicable, in the lists of sustainability factors affecting directors’ variable remuneration; (2) regulating the maximum percentage of share-based remuneration in the total remuneration of directors; and (3) a mandatory proportion of variable remuneration to be linked to non-financial performance criteria.
  • Sustainability expertise on boards: The Commission is also considering what steps boards might need to take to deepen their expertise on sustainability issues (e.g., by requiring number or percentage of directors to have environmental, social, or human rights expertise).

The Commission’s consultation questions overlap with, but also diverge significantly from, the European Parliament’s December 17 own-initiative resolution on sustainable corporate governance. (This is a procedure whereby the European Parliament asks the European Commission to put forward a legislative proposal on a given topic; the Commission is not obliged to do so.) As had been the case in the Parliament’s Legal Affairs Committee (“JURI”), the vote did not split cleanly down party lines. The left, center-left and green parties broadly supported the resolution, whereas both the center-right EPP group and the centrist Renew group splitting their votes for and against the resolution. (The right-wing ID and ECR parties broadly opposed the proposed text.) It is still unclear where the EU’s political consensus will lie on these complex issues.

Mandatory Human Rights and Environmental Due Diligence for Global Supply Chains

The public consultation includes the following crucial questions for companies on the form, scope and enforcement of human rights due diligence duties.

  • Form of the due diligence duty: How should a due diligence duty be framed? Should it be principles- and risk-based, leaving the decision on how to implement it to companies? Or should it instead more clearly define required actions and minimum processes that companies must follow?
  • Scope: Should the due diligence rules apply to companies that are not established in the EU, but that carry out certain activities in the EU? If so, how should the triggering “link” to the EU be defined?
  • Enforcement: What form should enforcement of the due diligence requirement take? The consultation alludes to both (i) judicial enforcement with liability and compensation in case of harm caused by not fulfilling due diligence obligations, and (ii) supervision by competent national authorities based on complaints (and/or reporting) about non-compliance, with effective sanctions (e.g., fines). It also entertains an EU cooperation/coordination mechanism to ensure consistent administration.

The consultation’s questions imply at least some divergence between the Commission’s ambitions with respect to due diligence and the thinking of Lara Wolters MEP. Wolters is the JURI Committee’s rapporteur on a draft own-initiative report on human rights and environmental due diligence, which is currently pending a committee vote. As noted above, Wolters’ report on mandatory human rights due diligence is far more detailed than the SCG resolution. It contains proposed legislative text for the Commission’s consideration, though the Commission need not follow this in its own proposal. Wolters’ report will be voted on in early 2021, with a first reading in the European Parliament slated for February 8, 2021.

As outlined in more detail in our October 2020 client alert, Wolters’ recommendations are far-reaching. They would require companies to:

  • Conduct due diligence not only on human rights and environmental risks, but also on governance risks (with a focus on anti-bribery and corruption);
  • Conduct due diligence on the entire value chain, which is defined broadly to include both direct and indirect business relationships, both upstream (e.g., with producers of raw material inputs such as minerals, water, or cotton) and downstream (e.g., with users of products such as cameras and algorithms).
  • Ensure that “due diligence” incorporates concepts in existing non-binding standards such as those of the UN Guiding Principles on Business and Human Rights (“UNGPs”). These could include risk assessments and due diligence strategies, mapping suppliers and subcontractors in the company’s value chain and binding them through contractual clauses, and establishing grievance mechanisms and internal governance structures (e.g., internal advisory committees).

If you have any questions concerning the material discussed in this client alert, please contact the following members of our firm.

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