Businesses will play a key role as they will be required to spot and mitigate any instances of unethical business practices such as child labour and worker exploitation in their activities. In this blog post we covered the most frequently asked questions on what the proposal means in practice and what implications it may have in businesses when it comes into place next year.
1 – What does the Proposal for a Directive on Corporate Sustainability Due Diligence include?
Environmental, Social and Governance (“ESG”) issues are becoming a huge issue for global corporates and governments. Across the world, scrutiny on the provenance of supply chains (the ‘how’, rather than only the ‘what’) is increasing as dubious practices and small markets for key raw materials are exposed through increasing pressure from shareholders, governments, pressure groups and the general public. The rise of so-called “greenwashing” claims, such as those recently involving H&M, KLM or Ryanair, mean that there is significant corporate risk in overstating or misstating a business’ credentials when it comes to all aspects of ESG. Greenwashing litigation – covering everything from vague, inaccurate, out of date, unsubstantiated, or false declarations about the company’s activities or products – is a trend which we expect to see continue to grow rapidly.
The main change in this fast-moving area is the European Commission’s draft Directive on corporate sustainability due diligence (“the Directive”). It was published on 23 February 2022, and although subject to change before becoming law, proposes significant changes in the field of human rights and environmental due diligence for supply chains around the world of in-scope organisations.
The Directive has broad coverage and will impact on three different classes of company. These classes are, according to the Commission: Group 1: Large EU limited liability companies: This will affect, according to the EC, approximately 9,400 companies. To be within scope of Group 1, the company must be based in the EU with 500 or more employees and have a net turnover of EUR 150 million or more worldwide. The second category is Group 2 companies, being approximately 3,400 companies in so-called “high-impact” sectors. The other criteria for a Group 2 company is that it must have 250 or more employees and have a net turnover of EUR 40 or more million worldwide. In addition, these companies must be operating in defined “high impact sectors”, which the Commission explains includes sectors such as “textiles, agriculture, or extraction of minerals”. In view of the high-risk nature of these businesses, the proposal is that the rules set out in the Directive “should start to apply two years later than for Group 1”. Group 3 covers non-EU companies but which have commercial activity in the EU and where the income to the relevant threshold is generated in the EU. The Directive will not apply to Small and Medium Sized Enterprises (SMEs) but there is scope for SMEs to be “indirectly affected” by some of the provisions of the Directive.
The Directive is perhaps the most headline grabbing change but other countries are following suit as ESG issues become more business critical. In the USA, proposals are being made by the Securities and Exchange Commission (SEC)’s investment committee to establish an ESG disclosure framework which could have far reaching consequences for businesses which are active in the USA. In other countries, such as France, voluntary codes of conduct in this area have seen significant take up from businesses.
2 – How does it differ to the Modern Slavery Act in the UK?
The UK Modern Slavery Act has been held out as a gold standard in protection against the most serious human rights threats and abuses. The Directive goes much further, enhancing the position under the MSA and with the potential to apply globally. It will drill down into all levels of the supply chain, from the raw materials through to the end reseller. It introduces new remedies including supervision, financial penalties, apologies, damages/compensation as well as orders to change behaviour. Unlike the MSA, it will apply to all businesses active and generating income in the EU.
3 – What standards or requirements is the legislation based on?
The Directive is based, partly, on the British Institute of International and Comparative Law study in 2020 which was commissioned by the EU. Whilst it draws inspiration from, amongst others, the United Nations Guiding Principles on Business and Human Rights (“UNGPs”), there has been some criticism that the Directive does not go far enough – particularly in relation to concerns that the Directive does not exceed existing standards such as the UNGPs in a number of areas and it does not cover the entire supply chain (excluding, as it does, SMEs).
4 – What actions should we be doing to demonstrate that we comply?
The Commission notes that affected companies will need to comply with a range of new obligations including:
The duty to build due diligence into company policies
Publish statements around their due diligence processes
To proactively monitor (for example, via an action plan) and to identify actual or potential negative impacts caused to human rights and the environment by their business, and then to mitigate these impacts
To take steps to prevent negative impacts caused by such business activities
A duty to set up a human rights/ESG complaints process
In addition, there will be a cost to change and a real need to ensure that the changes which are put in place are “right first time”.
5 – The changes in legislation appear to be EU or specific to individual nations, does it apply to UK companies?
Yes, it will. The Directive will apply to businesses who sell to the EU, not only those which are based in a Member State.
The third group of companies include those which are active in the EU and which have a turnover of more than €150 million in the EU or between €40 million and €150 million in the EU provided that at least half of that income is generated from the “high impact” sectors. This means that a range of UK businesses will be caught by the Directive and will need to comply with it to avoid sanctions. Although the UK need not, strictly, comply with the letter of EU law following Brexit, it seems likely that some form of similar regime may need to be introduced in the UK to enable its multinational businesses to be on the same footing in the EU.
The UK could need a supervisory authority in the same way as other Member States. Being out of sync with the EU could lead to patchy implementation and UK businesses being in breach of the rules in one Member State but not another, depending on how the rules are implemented in each country. In this way, ESG issues do not care about borders and this is a good example of how the UK continues to be in the sphere of EU law and governance.
An ethical supply chain is a sustainable supply chain
As an organisation you are expected to act safely, responsible and sustainably. Creating a transparent and collaborative supply chain committed to continually improving due diligence is a first step that businesses should already be taking in order to avoid any future penalties and reputational risk. Our Ethical Business Programme helps businesses assure all their stakeholders comply with international law, best ESG practice, and that all workers can live and work in line with their values. Request a call to find out more.
These FAQs were compiled by David Hansom, Partner and Head of Procurement Law at Clyde & Co, who specialises in aspects of global supply chain management and procurement.