EU to introduce mandatory corporate sustainability due diligence

On 23 February 2022, the European Commission adopted a proposal for a Directive on corporate sustainability due diligence. If enacted, it will mark a substantial shift in approach from what has always been a voluntary undertaking by businesses to protect their position, towards a mandatory approach in service of sustainability, human rights, and environmental considerations in companies’ operations and corporate governance.

The Directive looks to establish a corporate due diligence duty, with the core elements being identifying, preventing, and mitigating negative human rights and environmental impacts in the company’s own operations, those of their subsidiaries and their value chains. In addition, certain large companies will need to have a plan to ensure that their business strategy is compatible with limiting global warming to 1.5°C, in line with the Paris Agreement.

The proposed Directive also introduces duties for the directors of the EU companies that are in scope. These duties include setting up and overseeing the implementation of the due diligence process and integrating due diligence into the corporate strategy. On top of that, when fulfilling their duty to act in the best interests of the company, directors must take into account the human rights, climate change and environmental consequences of their decisions.

In total, this will affect around 13,000 EU companies (which is about 1% of the total), and 4,000 non-EU companies. Companies will be caught by the new requirements if they are large or considered high risk. In this case, that means respectively that they have over 500 employees and a net turnover of over EUR 150 million worldwide; or that they are operating in sectors like textiles, agriculture, or extraction of minerals, and have over 250 employees and turnover of at least EUR 40 million worldwide.

Failure to comply can elicit fines, and EU Members States must ensure victims are able to obtain compensation for damages resulting from the failure to comply with the obligations of the new proposal.

The proposal now needs to go to the European Parliament and the Council for approval. Once adopted, Member States would have two years to transpose the Directive into national law. Large companies will be affected first both inside and outside the EU, with the smaller high risk companies coming 2 years later. 

In due course, businesses will need to expend considerable resources and invest in expertise in order to understand, meet and monitor these new requirements, that will require them to take into account an even wider set of non-financial considerations when it comes to how they operate and govern themselves.