Corporate sustainability due diligence directive: the European Commission’s proposal

Last week, the EU set out its proposal for a new Directive on corporate due diligence to enhance the regulatory framework on sustainable corporate governance.

It aims to complement the Non-Financial Reporting Directive (NFRD) and the proposed amendments, revised under Corporate Sustainability Reporting Directive (CSRD) by adding a substantive corporate duty for companies to perform human rights and environmental due diligence to avoid potential harms in the company’s operations and value chain.

The requirements provide further clarity to the expectations of those pursuing sustainable investment objectives under the Sustainable Financial Disclosure Regulation (SFDR) and the Taxonomy Regulation (Taxonomy), particularly in relation to the consideration of principal adverse impacts of investment decisions on sustainability risks under the SFDR and the requirement to implement minimum safeguards under the Taxonomy respectively.

Who is in scope? 

• EU companies with more than 500 employees and €150m turnover will be in scope, and those with more than 250 employees and turnover of more than €40m could be in-scope, if at least half of that net turnover was generated in specific high-risk sectors.
• Non-EU with turnover more than €150m generated in the Union during the financial year preceding the last financial year, or a net turnover of more than €40m but less than €150m generated in the Union, if at least 50% of the net worldwide turnover was generated in the high-risk sectors listed above.
• SMEs are exempt.

What is proposed?

The Directive introduces a duty for directors to set up and oversee the implementation of due diligence and to integrate it into the corporate strategy, as well as a responsibility to take into account human rights, climate change and environmental consequences of their decisions in a manner that displays they are acting in the best interest of their business.

In-scope entities will have to:

• have in place a due diligence policy and integrate due diligence into corporate practice;
• identify actual or potential adverse impacts;
• prevent, mitigate potential adverse impacts, and bring actual adverse impacts to an end;
• establish and maintain a complaints procedure;
• monitor the effectiveness of their due diligence policy and measures; and
• publicly communicate on due diligence.

What are the consequences for non-compliance? 

National administrative authorities appointed by member states will be responsible for supervising these new rules and may impose fines in case of non-compliance.

In addition, victims will have the opportunity to take legal action for damages that could have been avoided with the proposed due diligence measures.

When is it coming into effect?

The proposal is yet to be approved by European Parliament and the Council. Once adopted, EU member states will have two years to transpose the Directive into national law.

What does it mean for UK based asset management and private equity firms?

UK firms will need to assess whether they or their wider group fall into scope of the Directive, and also consider the impact on their deal process and portfolio companies. Potentially aligning the adoption of this Directive to wider ESG programmes, or at least Taxonomy alignment initiatives, will give firms an edge in terms of implementing this Directive in a low risk and operationally efficient manner.