Supply chains, green and social due diligence and board accountability: What is the EU proposing on sustainable corporate governance?

The roles and responsibilities of the financial sector are yet to be determined

Human rights is a topic that’s been climbing the responsible investment agenda in recent years, but the EU’s current efforts to introduce rules to hold companies accountable for social and environmental risks in their supply chains could turbocharge that ascent.

It’s a move that’s been “a long time coming”, according to Steve Waygood, Chief Responsible Investment Officer at Aviva Investors, who attributes the growing awareness around the governance of human rights to three things: 

“There’s a greater awareness of problems facing the world, which is moving an electorate, therefore making it relevant to political circles. People can also connect with each other more rapidly through social media – leading to more coherent collective engagement and a greater ability for groups to express views. And then there is also a much better body of literature proving that ESG issues, managed properly, can enhance returns, and a greater recognition this occurs not just at the micro level for individual companies, but also at the macro.” 

There are already guidelines to address human rights breaches in the private sector – this year marks a decade since the launch of the UN Guiding Principles on Business and Human Rights, for example – but many feel this voluntary approach has fallen flat. “We're not only moving towards a more regulated environment because of the flagrant violations to human rights, which have been exacerbated by the pandemic,” says Sylvia Obregon Quiroz, Policy Officer at the civil society body the European Coalition for Corporate Justice. “But also because voluntary measures are clearly not sufficient”. 

‘Rather than litigation or fines, a more effective mechanism would be to debar directors who are in persistent infringement of these governance proposals from serving as directors’ – Steve Waygood

European policymakers clearly agree, because they’ve tabled a sweeping new legislative proposal called Sustainable Corporate Governance. As they stand, the plans will require “companies to take measures to address their adverse sustainability impacts, such as climate change, environmental, human rights (including workers and child labour) harm in their own operations and in their value chain by identifying and preventing relevant risks and mitigating negative impacts”.

It is also considering forcing “company directors to take into account all stakeholders’ interests which are relevant for the long-term sustainability of the firm or which belong to those affected by it, as part of their duty of care to promote the interests of the company and pursue its objectives”. 

In addition, it wants “to define and integrate stakeholders’ interests and corporate sustainability risks, impacts and opportunities into the corporate strategy – following appropriate procedures – with measurable and time-bound, science-based targets where relevant and according also to the company’s size and activity, and to implement such strategy through proper risk management and impact mitigation procedures”.

The proposal acknowledges some EU countries already have such policies (France, for example, has a Duty of Vigilance Law), but claims an EU-wide directive would prevent “market fragmentation” and provide legal certainty and a level playing field for companies. By being a Directive (as opposed to regulation), Member States will have some freedom to decide how they roll the rules out in their jurisdictions.

So what’s prompted this initiative? Well, the proposed directive is considered the final piece of the EU’s Action Plan on Sustainable Finance. Launched in 2018, the action plan laid out 10 objectives to help reduce economic risks and foster sustainable finance in Europe. Famously, the Action Plan gave rise to the EU’s green taxonomy, and its disclosure rules for investors (which come into force this week), as well as new laws for index providers, new guidance for companies on what sustainability-related factors they need to report on, and much more. But the final objective – ‘Action 10’ – was dedicated to “sustainable corporate governance”, and was arguably ignored by the EU’s unit for Financial Stability, Financial Services and Capital Markets (known as FISMA), which was spearheading the Action Plan. 

Last year, though, the Directorate General for Justice and Consumers picked up the baton and created this latest legislative proposal, which is now going through an impact assessment, with a final proposal expected by the end of June.

Alongside this work by the European Commission, in January the Legal Affairs Committee of European Parliament approved a draft legislative initiative advocating for corporate mandatory human rights and environmental due diligence. The report, Corporate due diligence and corporate accountability, is expected to be given the green light by the whole parliament at a vote this week. Then, according to Lara Wolters, the Member of European Parliament overseeing the initiative, “the balls in the court of the Commission”.

Speaking on a recent webinar, Wolters continued: “The Commissioner has committed to not put our report into a drawer somewhere, but to base legislation on it, to at least to come up with an official proposal on due diligence towards the summer.”

Some investors are already responding positively to the plans. RI reported earlier this year that Norges Bank Investment Management – representing Norway’s sovereign wealth fund, one of the biggest asset owners in the world – welcomed the Sustainable Corporate Governance proposal during its consultation phase, and supported the suggestion that directors’ remuneration could be used to incentivise focus on long-term value creation.

‘If a bank grants a loan to an oil company that damages the Arctic, it is essentially financing environmental degradation. It needs to be aware of this impact and address it’ – MEP Lara Wolters

Unsurprisingly, though, the business world is warier. In another consultation response, EuropeanIssuers, the trade body representing more than 70% of European public companies, said it “strongly disagreed” with legally requiring directors to manage possible risks and adverse impacts across stakeholders. It also objected to the proposals on supply chain due diligence, arguing they could relate to “hundreds and thousands” of suppliers and could hit smaller companies hardest. It did say it could get behind a legal framework focused on the relationships between companies and first tier suppliers, but NGOs argue that most human rights violations fall further down the supply chain than that. 

Wolters says most of the pushback so far has been about liability and proportionality. 

“On the former, companies were concerned that they would be held liable for situations they could not have foreseen or could not have reasonably prevented,” she observes. “On the latter, we have sought to make proportionality a core principle and to tailor due diligence obligations, where possible, to the size, nature and risk profile of the company concerned.”

Aviva’s Waygood says that some elements of the plans still need to be clarified for investors – especially when it comes to sanctions. 

“Currently, if a large listed company gets fined or faces legal action, it's a one-off hit, and it tends to have a very small overall impact. In the vast majority of cases it's almost looked at like a rounding error – it doesn't matter at all to the ongoing activity of the business. It might impact the culture of the business, or raise concerns about the quality of management, but the actual number has to be significant for it to materially impact the longer-term revenues of most businesses and change behaviour,” he says. 

He believes one solution could be to focus the Directive on individual board members. “Rather than litigation or fines on the company, a simpler and arguably more effective mechanism would be to debar directors who are in persistent infringement of these governance proposals from serving as directors.”

NGOs including the ECCJ are asking for the creation of a regime focused on civil liability – including tools to help victims get justice – but enforced by Member States using “criminal liability or equivalent instruments”.

In what Wolters recently described as taking “one step at a time”, the Legal Affairs Committee wants to focus on civil liability. 

The current legislative proposal covers Limited Liability Companies, but the Legal Committee’s initiative wants this extended to cover all corporations operating in the EU internal market, including banks and investors.

It’s a move that Waygood is cautious about: “We’re not for a second suggesting that finance isn't relevant, it absolutely is,” he tells RI. “And of course we should be doing our own due diligence on the companies we own – that's what we think of as fundamental research. But we need to think about which of the policy directives is the right one to take things forward.” 

Wolters explains that, if financial institutions are included in the final plans, those rules will fall within the remit of Parliament’s Economic Affairs Committee. But she is certainly supportive. 

“If a bank grants a loan to an oil company that damages the Arctic, it is essentially financing environmental degradation,” she says. “It needs to be aware of this impact and address it where necessary.” 

She believes that, so far, the EU’s work on sustainable finance has been limited to improving disclosure and preventing greenwash. But, she says: “Through due diligence legislation, we would fill the gap that currently exists with regard to behavioural rules.