On February 23, 2022, the European Commission published its eagerly awaited draft Directive on Corporate Sustainability and Due Diligence (Draft Directive). The draft directive sets out a proposed EU Human Rights and Environmental Due Diligence (HREDD) standard that would apply primarily to any Asia-based company and its subsidiaries where those group companies have a total annual net turnover in the EU of:
- more than EUR 150 million (group 1); or
- more than EUR 40 million, with at least 50% of global net sales generated in a “high risk” sector comprising textiles, clothing and footwear, agriculture, forestry, fisheries, food and commodities (Group 2).1
In particular, HREDD applies even if the Asia-based companies and their subsidiaries do not have a physical presence in the EU when the above net sales threshold is reached.
The draft policy requires both Group 1 and Group 2 companies to take appropriate steps to identify and mitigate actual and potential adverse human rights and environmental impacts arising from their own operations anywhere in the world (not only in the EU) and, where related, result in their value chains, from their “established business relationships”.
According to the draft directive, the EU member states are obliged to:
- appoint a supervisory authority to monitor compliance with due diligence and climate change obligations with appropriate powers and resources to request information, conduct investigations, order remedial action and impose fines;2 and
- ensure that individuals and organizations can bring civil claims.3
The draft directive provides for the responsibility and accountability of directors in relation to EU companies’ HREDD programmes.4 Group companies that reach the turnover threshold must also appoint an EU-based representative to liaise with EU regulators.
While still subject to further legislative review and approval, the draft policy provides the most detailed insight yet into the scope and shape of future HREDD obligations and provides a useful template for organizations to further develop their due diligence policies and procedures to identify, assess and mitigate adverse ones Human rights and environmental impacts – both in their operations and in their value chains.
In addition, the draft directive will impact Asia-based banks, insurers and other financial institutions that meet the EU net sales threshold. They have additional due diligence requirements for customers and their affiliates to whom they provide loans, credit and other financial services5 in line with the requirements of the draft directive.
Globally growing HREDD trend
The overall message is clear: Mandatory HREDD is coming, and Asia-based companies should already be preparing for forthcoming HREDD legal obligations and rising stakeholder expectations in this area. Although HREDD legislation originally focused on child labor and slavery (UK, Australia, California), the trend is towards a broader and more global perspective on human rights and the environment. We see this in the recent laws passed in Norway, Germany and the Netherlands over the past year (see our past blogs on national HREDD movements in Germany and the Netherlands). Japan is expected to issue corporate human rights guidelines later this year. In addition, certain securities exchanges in Asia have adopted or proposed ESG-related disclosure requirements that are broad enough to cover disclosures of information related to specific social issues, including human rights.
Key highlights of the draft policy
key to take away: In principle, the draft directive would require Group 1 and Group 2 companies to implement HREDD measures that cover their entire value chains and include “established business relationships” throughout the value chain beyond Tier 1 suppliers. This includes contractors, subcontractors and other companies in the supply chain. This will make supply chain risk assessment and ongoing supply chain risk management even more complex in practice.
key to take away: The draft directive requires directors of EU-based subsidiaries of Asia-based companies to consider “human rights, climate and environmental impacts” when acting in a company’s best interests. This also includes the requirement that a company’s business model and strategy be compatible with the 1.5 °C target of the Paris climate agreement. This appears to be more far-reaching than existing and expected national HREDD legislation.
key to take away: The draft directive requires member states to establish rules on sanctions for non-compliance, ensure such sanctions are “effective, proportionate and dissuasive” and may include fines based on a company’s turnover.
NEW LIABILITY REGULATION
key to take away: A new civil liability regime could set the stage for an increase in human rights and environmental litigation (e.g. by civil society organizations). In addition, this regulation will have an impact on existing national due diligence laws that currently do not provide for such a regulation (e.g. the German Supply Chain Act).
Model clauses and guidelines
key to take away: The European Commission is expected to issue guidance and a set of voluntary model clauses to help companies meet their obligations under the draft directive. Our previous blog on ABA model clauses provides insights into the types of voluntary model clauses that are already available in a supply chain context.
schedule and implementation
The draft directive will now be submitted to the European Parliament and the Council for approval. Once adopted, member states have two years to transpose the directive into national law.
How can your organization prepare for the requirements of the draft policy?
The outline of due diligence requirements in the draft policy gives a good indication of the scope and likely expectations for the design and implementation of a human rights and environmental due diligence program. Asia-based groups likely to fall within the scope should begin to map, align and leverage their existing policies and procedures to the requirements of the draft policy (particularly those in Articles 5-11) to identify gaps and areas for improvement before adopting the draft directive. For many large companies, designing and implementing appropriate systems and controls and embedding them in “business as usual” could in many cases be a multi-year, multi-stakeholder exercise, and therefore it is imperative for companies to prepare for these new commitments in a hurry .
More generally, companies can position themselves on the draft directive and other mandatory HREDD legislation emerging at the national level by:
- integration of human rights into corporate policies and strategic planning processes;
- disclosure of how human rights considerations are integrated into strategies, policies and procedures;
- Carrying out a human rights impact assessment and taking appropriate countermeasures as well as internal and external communication of the measures taken;
- reviewing and strengthening grievance mechanisms and speak-up programs;
- Ensuring that the company is well equipped to deal with “crises”;
- reviewing the extent to which its Board of Directors is prepared to address supply chain risks; and
- Reviewing the role, resources and expertise of the legal and compliance functions, which should play a key role in addressing these new challenges.
Read more about our business and human rights perspectives here.
1 Group 1 companies are subject to less due diligence (they only need to focus on significant adverse impacts relevant to their industry) and, for example, do not have specific commitments to address climate change as required for Group 2 companies.
2 The supervisory authority can initiate an investigation on its own initiative or on the basis of “reasonable concerns” communicated to it. In the event of violations, the supervisory authority grants the company concerned a reasonable period of time in which to remedy the situation if possible. If no correction is made, it can impose fines (Article 18).
3 Member States must allow individuals/organisations to raise “reasonable concerns” and ensure they have access to a court or other impartial body to raise their concerns (Article 19).
4 This would apply to directors of EU-based subsidiaries but not, for example, directors of the Asian-based parent company.
5 “Other financial services” are not explicitly defined in the draft directive.