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EU Corporate Sustainability Due Diligence draft directive adopted

Author: ICAEW Insights

Published: 02 Mar 2022

Controversial proposals will impose new obligations on companies active in the EU on how they monitor and operate in their supply chains, alongside new duties for directors.

After a delay of several months, controversial proposals on sustainable corporate due diligence have been adopted by the European Commission that will impose new obligations on companies and on how they monitor and operate in their supply chains, alongside new duties for directors. 

The draft Directive on Corporate Sustainability Due Diligence issued last week will force large companies operating in the EU – including non-EU companies – to check that their suppliers around the world respect environmental standards and do not use slave or child labour. The draft rules also introduce an obligation on directors to ensure that their business strategy is Paris-aligned. 

Under the new proposals, companies will be required to identify and, where necessary, prevent, end or mitigate adverse impacts of their activities on human rights, such as child labour and exploitation of workers, and on the environment. 

In addition, the largest 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 proposals also introduce directors’ duties to set up and oversee the implementation of due diligence and to integrate it into the corporate strategy. 

Thierry Breton, Commissioner for the Internal Market, said complex global value chains make it particularly difficult for companies to get reliable information on their suppliers’ operations and the fragmentation of national rules further slows down progress in the take up of good practices. “Our proposals will make sure that big market players take a leading role in mitigating the risks across their value chains while supporting small companies in adapting to changes.” 

Initially the proposed rules will apply to all EU limited liability companies with 500-plus employees and more than €150m in net turnover worldwide. Non-EU companies active in the EU meeting turnover thresholds generated in the EU will also be affected. The proposal applies to the company’s own operations, their subsidiaries and their value chains including direct and indirect established business relationships.

The Commission says the new EU rules will advance the green transition, protect human rights in Europe and beyond, and bring legal certainty and a level playing field to business, while consumers and investors will benefit from increased transparency. However, MEPs from the centre-left, liberal and green parties have criticised the text as being unambitious.

Accountancy Europe, the representative organisation for the accountancy profession in Europe, whose members include ICAEW, described the proposal as a global milestone but warned that further clarity on some aspects was needed, in particular the extent of companies’ responsibilities and legal certainty regarding directors’ duties of care. It added that due diligence verification by independent third parties (be it the statutory auditor or another service provider) would be crucial to strengthening stakeholders’ confidence in this process.

“We support the Commission’s efforts to include key third country companies in the proposal and create a level playing field for EU businesses. Value chains are global, and companies integrating sustainability in their operations should not face unfair competition from companies (third country or EU) that do not take this responsibility,” Accountancy Europe said in a statement.

Peter van Veen, ICAEW’s Director of Corporate Governance and Stewardship, said ICAEW supported the aims of the directive, but it would only be effective if applied consistently across the EU so that companies were not faced with different national regulations and expectations when it comes to supply chain due diligence. “It would be counterproductive if there were significant differences in local implementation as this will lead to confusion and ineffective implementation. Clear guidance from the EU on what good looks like for companies in terms of adequate procedures, reporting and measuring effectiveness would be very welcome as this will help the various national legislatures provide consistent guidance of what is expected.” 

Meanwhile, Business Europe, an umbrella body for business federations across Europe, said it was unrealistic and added excessive red tape on businesses. Pierre Gattaz, President of BusinessEurope, said the Commission proposal fell short of delivering workable rules for businesses and added to the already excessive burden imposed on business in recent years. “It is unrealistic to expect that European companies can control their entire value chains across the world, including ‘indirect’ third-party suppliers or even customers.”

“We acknowledge the aim to partly exclude SMEs from the proposed obligations, but they will still be impacted and burdened indirectly,” Gattaz added. “The use of complex and unclear terminology leaves too much room for EU Member States to add-on, which could eventually lead to a patchwork of rules undermining one of the initiative’s main objectives: the prevention of fragmentation of rules within the single market.”

The next stage in the process is for the text to be scrutinised by the Council and Parliament. Once adopted, Member States will have two years to transpose the Directive into national law and communicate the relevant texts to the Commission.