In our “What to expect in 2021” blog, one cross-sectoral EU initiative we flagged was forthcoming Commission proposals for far-reaching new EU-wide Sustainable Corporate Governance requirements.

Here are some more details of what that might entail.

Background

Recent studies have suggested that companies performing well on ESG factors outperform their peers and that those with better social and environmental performance have proved to be more resilient to the COVID-19 crisis.

Against this explicit backdrop, the Commission’s initiative on sustainable corporate governance aims to foster long-term sustainable and responsible corporate behaviour across the Union to support and drive many of the EU’s other flagship ESG policies including the Green Deal, the climate neutrality by 2050 commitment, the Action Plan on the Circular Economy, the Farm to Fork strategy and others, as well as delivering on the EU’s commitments to meet the UN’s Sustainable Development Goals.

To that end, the Commission has promised to introduce legislative proposals this year relating to a range of environmental, social and governance (ESG) issues including the protection of essential human rights, environmental supply chain due diligence, enhanced directors’ duties and sustainable corporate governance.

The initiative is also complementary to the ongoing review of the EU’s Non-Financial Reporting Directive, according to which large public-interest companies need to disclose non-financial (such as environmental/climate change) information. The Commission considers that the reporting obligation in the NFRD needs to be more firmly underpinned by a corporate obligation to actually carry out due diligence on such matters.

The initiative seeks to beef up the EU regulatory framework on company law and corporate governance with the goal of pushing companies to focus more on long-term sustainable value creation instead of short-term benefits and better manage sustainability-related matters as part of their own operations and value chains concerning social and human rights, climate change and the environment. A key aim is to re-balance what the Commission sees as a current imbalance between short-term shareholder profit and longer-term, sustainable growth and investment.

The initiative builds on two market studies the Commission undertook last year, which sought to identify obstacles to businesses’ transition to an environmentally and socially sustainable economy.

One of the studies considered directors’ duties and sustainable corporate governance. The study concluded that sustainability was more often than not disregarded, making EU intervention necessary to strengthen the role of directors in combining long-term company profitability and sustainability.

The second study focussed on the role due diligence has to play in tackling adverse sustainability impacts, including human rights issues and climate change. According to the study, merely a third of EU businesses currently undertake adequate due diligence on human rights and environmental impacts.

Specifics

ESG legislation of various kinds already exists in some EU countries (NL, FR, IT for instance) and is under development in many others. However, the Commission sees it as vital to create a pan-European “level playing field” on such issues rather than allow fragmented national intervention, and that is an objective likely to be shared by most multi-national companies.

The Commission is due to publish a formal proposal in furtherance of this initiative in Q2, although a first glimpse of where the new initiative is heading may already become visible in the Commission’s Renewed Sustainable Finance Strategy, expected to be published in the coming months.

Specific proposals may take the form of revisions to the EU’s company law directive (2017/1132) and the directive on shareholder rights (2007/36) and/or completely new legislation/guidance and are likely to include some combination of the following:

  • A possible new corporate due diligence duty requiring companies to establish and implement adequate processes for preventing, mitigating, and accounting for human rights, health, and environmental impacts in companies’ operations and supply chains (building on established definitions developed by the UN and OECD which we already see reflected for example in the EU Timber Regulation and the EU Conflict Minerals Regulation and expanding such requirements into a much wider range of products/sectors);
  • Options to enhance sustainability expertise in the board;
  • methods of integrating sustainability into corporate strategy and decision-making by, for example:
    • changing the basis for remuneration of directors and tying it to more closely to non-financial performance (such as by measurable and time-bound sustainability metrics); and
    • strengthening the role of civil society stakeholders groups (e.g. those representing employee or environmental concerns) in the enforcement of directors’ duty of care; and
  • introducing appropriate enforcement measures accompanying these new duties, including the possibility for required remediation in the event of non-compliance.

This initiative symbolises a significant further step in the EU’s sustainability/ESG policy programme.