Introduction
ESG-related disclosure and reporting requirements
Purpose and standards of social sustainability reporting
Implementation of social sustainability criteria in HR management
Recent legislative and other developments linked to "S" in ESG
Comment
A company's ability and commitment to include environmental, social and governance (ESG) factors in its strategy is becoming increasingly important to investors, consumers, policymakers, civil society organisations and other stakeholders. A fundamental societal shift towards sustainability and responsibility is occurring in Germany, and managers are being held accountable for ESG compliance.
While environmental and governance aspects have always been key criteria, social sustainability criteria such as diversity and inclusion, human rights, health and safety at work, and equal employment opportunities for minorities have become a focal point only more recently. Many German companies still have a rather vague understanding of what ESG actually means and how ESG criteria can be addressed by their compliance functions. At the same time, disclosure and reporting obligations make companies' approach to ESG transparent for both internal and external stakeholders, so looking into this topic behind closed doors is no longer an option.
ESG-related disclosure and reporting requirements
The number of hard and soft law requirements for the disclosure of non-financial information in the corporate reports of larger German companies is growing, particularly regarding the environmental and social impacts of their activities. Above all, the EU Corporate Sustainability Reporting Directive (CSRD) (for which a proposal is currently in the legislative process), as well as the EU requirements on sustainability-related disclosure obligations in the financial sector, which primarily concern employee matters, should be mentioned. The CSRD is expected to replace the existing EU Non-Financial Reporting Directive (NFRD),(1) which has been considered as responding insufficiently to the desire of stakeholders to receive adequate and detailed sustainability information.
Under the NFRD, only large public-interest companies with more than 500 employees and parent companies of groups with more than 500 employees on a consolidated basis have been required to publish information with respect to:
- environmental matters;
- social matters and the treatment of employees;
- respect for human rights;
- anti-corruption and bribery; and
- diversity on company boards (in terms of age, gender, educational and professional background).
Unlike the NFRD, which applies to approximately 500 companies in Germany, the CSRD is expected to ultimately apply to almost 15,000 companies in Germany.
According to the existing proposal, Germany will have to implement the CSRD by 31 December 2022. Larger German companies will have to meet certain reporting standards from 1 January 2023 and a second set of standards from 23 October 2023. "Large companies" are defined as those meeting at least two of the following criteria:
- €40 million in net turnover;
- €20 million on the balance sheet; and
- 250 or more employees.
Small and medium-sized German enterprises will have to comply with the CSRD reporting standards only from 1 January 2026.
The CSRD proposal intends to make sustainability reporting requirements more consistent with the existing sustainable finance legal framework, including the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation, and align with the objectives of the European Green Deal.
Purpose and standards of social sustainability reporting
Ultimately, all of these disclosure and reporting requirements – to the extent related to social sustainability criteria – serve to provide meaningful information on the strategic importance of the workforce and its value-add as well as on any personnel-related risks within a corporate organisation. The ultimate purpose is to increase the value of the company in the medium and long term. For the practical implementation of these reporting requirements in human resource management, standards and criteria are needed for employment-related matters.
A number of non-binding standardisation initiatives are available for German enterprises, including:
- the Global Reporting Initiative standards;
- standards developed by the Sustainability Accounting Standards Board;
- the German Sustainability Code; and
- the German Institute for Standardization International Organization for Standardization standard 26000 guideline.
These standards provide criteria for ESG-compliant reporting – in particular, on traditional labour law topics such as:
- occupational health and safety;
- co-determination;
- anti-discrimination/diversity and inclusion; and
- employee data protection.
In practice, corporate social sustainability reports often have a narrow scope and focus on human rights compliance, employment promotion and charitable initiatives. ESG-compliant reporting around social sustainability goes much further, so German companies have quite an information gap to fill. Social criteria are often harder to measure than, for instance, environmental exposure. This is one of the reasons why social sustainability reporting lags behind.
Implementation of social sustainability criteria in HR management
Social sustainability criteria should not only be reporting items, but should be something that German companies and their leadership live up to. ESG reporting should not be viewed as just another requirement that German companies have to meet. Rather, it is an opportunity to provide the desired clarity to investors and other stakeholders who want to assess the value-add for a company that is associated with the human component. The following are common areas of interest when it comes to German companies acting in a socially sustainable way:
- consideration of ESG criteria in executive compensation/executive compensation metrics;
- consideration of responsible investment criteria in company pension systems/pension investment;
- occupational health and safety;
- diversity and inclusion;
- employee data protection/privacy;
- whistle-blowing;
- agile working/home office;
- pandemic management;
- deployment of external personnel;
- employee mobility and migration;
- company training and qualification; and
- co-determination.
Recent legislative and other developments linked to "S" in ESG
Act on Corporate Due Diligence Obligations in Supply Chains
The Act on Corporate Due Diligence Obligations in Supply Chains will enter into force on 1 January 2023. It is intended to ensure that internationally accepted human rights standards and certain environmental standards are observed. While the new law will initially apply only to companies or groups of companies that normally have more than 3,000 employees, a lower threshold of 1,000 employees will apply from 2024.
Companies will be required to perform risk assessments in their supply chains and make reasonable efforts to avoid, mitigate or eliminate violations. The Act establishes certain reporting obligations and documentation requirements. There is also an obligation to set up a whistle-blower system. When it comes to renegotiating or concluding new supplier contracts, provisions will have to be included to allow companies to take preventive measures and enable the proper selection and monitoring of suppliers and sub-suppliers.
Companies that do not meet the legal requirements under the Act can be faced with administrative fines and penalty payments. Depending on the type and severity of the violation, the maximum amount for administrative fines is €800,000 or, for companies with an annual revenue of more than €400 million, up to 2% of the average annual revenue of the past three fiscal years of the economic unit to which the company belongs. Companies that have been subject to a high fine can be excluded from public tenders and public contracts for up to three years.
Second Law to Increase the Number of Women in Leadership Positions in Private and Public Sector Companies
The Second Law to Increase the Number of Women in Leadership Positions in Private and Public Sector Companies entered into force in August 2021. For publicly traded companies that are codetermined (ie, that regularly employ more than 2,000 employees), fulfilling the previously existing obligation to have at least 30% women and 30% men in supervisory board positions will no longer be sufficient.
From 1 August 2022, private companies that are publicly traded and codetermined will also be required to appoint at least one woman and one man to any management board that has more than three members. For other private sector companies that have either been publicly traded or codetermined, the obligation to set a target figure for female representation on the supervisory board, management board and at the two managerial levels below the management board continues to exist.
Previously, it was legally acceptable to set the target figure for female representation to zero, provided that this did not lead to a decrease in female participation. Going forward, setting the target figure to zero will need to be explained in detail and included in the company's annual reporting. The explanation must describe the considerations made, including, without limitation, the facts assessed and how they were weighted by the supervisory board. The explanation must be sufficiently detailed to make a conscientious decision plausible to the public.
Companies that fail to report a target figure or that fail to justify a zero target properly will be faced with fines of up to €10 million, or 5% of the annual turnover, or twice the amount of the economic benefit gained for publicly traded companies. For companies in which the federal government is the majority shareholder, even stricter rules apply, and the long-term objective is to achieve equal participation of women and men by the end of 2025.
Social sustainability criteria are becoming increasingly important for German companies. In addition to dealing properly with short-term developments, such as the handling of the covid-19 pandemic and managing its impact on the workforce, a significant number of legal requirements in the social space impact the long-term journey of German businesses. German companies need to be aware of what their obligations are, what compliance mechanisms they should implement, how they can efficiently measure their level of social sustainability, and ultimately market their results, in the best interest of both themselves and their workforce.
For further information on this topic please contact Hagen Köckeritz at Mayer Brown by telephone (+49 69 7941 0) or email ([email protected]). The Mayer Brown website can be accessed at www.mayerbrown.com.
Endnotes
An earlier version of this article was published in Labor Law Magazine.