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The U.S. Securities and Exchange Commission (“SEC”) is not the only entity that is looking to potentially mandate standards by which corporate securities issuers must disclose material environment, social, and governance (“ESG”)-related risks associated with their businesses. Right around the time that the SEC called on investors, registrants, and other market participants to provide public comment on its current climate change disclosure policies and practices, and insight on how the agency can “best regulate, monitor, review, and guide climate change disclosures” going forward, European Parliament formally set out recommendations to the European Commission that focus on ESG-centric corporate due diligence and accountability. 

In a release on March 10, Parliament revealed that it has adopted a legislative initiative report that “calls for the urgent adoption of a binding European Union law that ensures companies are held accountable and liable when they harm – or contribute to harming – human rights, the environment and good governance,” and that “guarantees that victims can access legal remedies.” As such, the newly-revealed directive consists of two core issues: the adoption of mandatory due diligence obligations for companies, and the establishment of rights for individuals and stakeholders to hold companies liable for non-compliance.

On the due diligence front, EU legislators asserted that the rules would “obligate companies to identify, address and remedy aspects of their value chain (all operations, direct or indirect business relations, investment chains) that could or do infringe on human rights (including social, trade union and labor rights), the environment (contributing to climate change or deforestation, for example) and good governance (such as corruption and bribery).” It is worth noting that Parliament “proposes a wide definition of value chains, catching all business and investment activities, including direct and indirect business relationships upstream and downstream,” according to White & Case LLP’s Jacquelyn MacLennan, Clare Connellan, and Louise Lundberg.

The MEP proposal, in connection which the European Commission will present its legislative proposal in Q2 of this year, will “set the standard for responsible business conduct in Europe and beyond,” Parliament stated, as it would not only apply to companies based in the EU but would also be binding upon companies headquartered elsewhere but that operate within the 27-member-bloc. “Companies that want to access the EU internal market, including those established outside the EU, would have to prove that they comply with environmental and human rights due diligence obligations,” the release revealed. 

Aimed at “increasing the accountability and transparency of EU businesses whose operations may impact human rights, the environment, and governance,” Vinson & Elkins LLP attorneys Martin Luff and Andrew Cox say that the proposed rule would require that companies “evaluate due diligence strategies and risk assessments annually,” and be prepared to disclose “the potential and/or actual adverse human rights, environmental and good governance impact that [their] own activities and those of their value chains and business relationships may pose.” Failure to comply with the proposed rule – if it is, in fact, implemented – “could carry significant consequences, including substantial monetary penalties [potentially based on a company’s revenue], temporary suspension of business operations, and even criminal penalties for recurrent, intentional violations.”

As for what companies would be impacted, the proposed legislation is slated to apply to all “large” companies operating in the EU, including private or state-owned entities, as well as to all publicly-listed or “high-risk” small and medium-sized enterprises, and companies providing financial products and services.

Not to be overlooked, the proposed plan to “enhance due diligence requirements and monitoring obligations has the potential to create a harmonized standard for due diligence and legal certainty across the board,” according to a client note from Baker McKenzie, thereby, going beyond the voluntary and non-binding principles and standards that are currently in place thanks to international organizations, such as the United Nations and the OECD. At the same time, Baker McKenzie contends that such legislation would likely “also lead to increased regulatory obligations and associated costs for companies with complex global supply chains, which will need to review and adapt their processes accordingly.” To limit the “administrative and financial burden, the European Commission has indicated that it aims to find a balance between the requirements [of Parliament’s proposed directive], and the cost to individual companies and the EU as a whole,” per MacLennan, Connellan, and Lundberg.

In terms of what the law will ultimately look like, MacLennan, Connellan, and Lundberg say that they expect that it will “be broader than existing national regulations, and will apply in addition to national requirements,” meaning that “companies operating in EU countries will have to comply with the stricter requirements in force, whether based on national or EU requirements.”

While experts reveal that the draft directive still has a “long way to go” before becoming law (assuming, of course, that the European Commission accepts it, and it is implemented into the laws of the individual EU member states; a timeline of adoption in 2021 and possible enactment in 2023 has been floated), it, nonetheless, “continues the recent trend towards the implementation of meaningful and ongoing due diligence obligations regarding human rights, the environment, and good governance, with real consequences for non-compliance” both in the EU and in the U.S., as well