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Sustainable Corporate Governance – accounting for your supply chain

Supply chains of European businesses often stretch far beyond the EU territory, where the EU’s environmental, social and human rights may no longer apply. Consumers increasingly expect companies to « do no harm » throughout their operations and supply chain. To this end, as also announced in the European Green Deal and in accordance with the UN Sustainable Development Goals, the European Commission will, in the second quarter of 2021, introduce new rules on incorporating sustainability in long-term business strategies. This proposal for sustainable corporate governance will create a new framework to give sustainability a more prominent role in the board room, while reviewing the obligations companies currently have under the Non-Financial Reporting Directive. As the new legislation is expected to place additional reporting obligations on many European companies, this article will take a look at its expected scope and impact on your company’s business activities.

The future EU corporate governance framework should steer companies towards more long-term visions that incorporate sustainability, which in this context not only includes their environmental impact but also human and social rights. A powerful instrument to achieve this could be the introduction of due diligence duties. These duties could not only require companies to respect their own employees’ working rights and limit their own environmental footprint, but it would also oblige companies to actively trace the conditions under which early production processes further up the supply chain take place. For example, did your direct supplier pay a fair price to the farmer he bought cocoa from? And what can a company do to make sure these farmers produce in a sustainably sound way?

Currently, some multinational companies and national governments are taking a frontrunner role in tackling these kinds of questions. However, a failure to create a level playing field in the EU with regard to due diligence obligations could hamper companies’ willingness to keep on taking on this leadership role. The EU’s proposal for a horizontal sustainable corporate governance framework should incentivize broader categories of companies to undertake due diligence.

The proposal for a sustainable corporate governance framework will go hand in hand with a revision of the Non-Financial Reporting Directive (NFRD), which currently requires large companies to disclose information on their handling of social and environmental challenges.

A European solution will have to balance the need for a level playing field and the risks of overburdening smaller companies with new obligations. As the Commission currently still is in the process of carrying out an impact assessment, the exact categories of sectors and product groups to be included in the scope will still need to be determined in the upcoming months. Although it is evident that the Commission’s Directorate-General for Justice and Consumers (DG JUST), responsible for the sustainable corporate governance proposal, intends to include all industries in this horizontal framework, it is still undecided if, for example, SMEs will be included in the Directive’s scope.

What do we already know about the proposal for a sustainable corporate governance and how could this impact European businesses?

The proposal for a sustainable corporate governance framework will go hand in hand with a revision of the Non-Financial Reporting Directive (NFRD), which currently requires large companies to disclose information on their handling of social and environmental challenges. Even though this revision of the NFRD could clarify the requirement to report on due diligence processes, this would not yet be underpinned by an obligation to undertake due diligence, including mitigation of negative impacts.

This could be addressed by the sustainable corporate governance proposal, which could oblige companies to identify and mitigate risks relating to human rights, climate and environment. Where the UN Guiding Principles on Business and Human Rights currently lay down steps for e.g. proper human rights due diligence, the EU could give this a binding character through its proposal for a Directive, obliging Member States to transpose a due diligence obligation into national law.

Moreover, the proposal could oblige company directors to take into account sustainability aspects in the formulation of corporate strategies, by requiring them to set science-based and time-bound targets for e.g. climate, deforestation and biodiversity, including the set-up of the necessary enforcement mechanisms. The Commission is currently still in the process of developing the appropriate methodology for clear targets and benchmarks.

With the exact impact still dependent on the choices the Commission will make in the upcoming months and the feedback provided by stakeholders in the process, strict due diligence requirements and duty of care for directors could increase the organizational and administrative burden for companies to set up internal processes including reporting and transparency obligations. These obligations would come on top of the obligation to disclose business strategy information under the revised NFRD. Even if the Commission encourages sustainable corporate governance through voluntary instruments, companies will be pressured to incorporate sustainability in their business strategies.

Next steps

The European Commission recently ran a public consultation on sustainable corporate governance. The outcomes of this public consultation will complement the results of two studies conducted by the European Commission on Directors’ duties and sustainable corporate governance, and on due diligence requirements through the supply chain.

After that, the European Commission will make the choice between various policy instruments and finalize the legislative proposal for a Directive, which is expected to be published by the European Commission in the second quarter of 2021.

If you would like to determine the impact the EU’s sustainability initiatives have in your specific case, check out our European Green Deal Impact Scan, or learn more about our monitoring services to receive regular updates on this topic.