EU Draft Law Requires ESG Compliance Within Supply Chains

A new law would require EU-based companies to monitor their global supply chains for ESG offenses.

In late February, the European Commission —  the executive branch of the European Union, unveiled a proposal called the Directive on Corporate Sustainability Due Diligence. The proposed initiative would require large companies operating in the European Union to ensure their global suppliers do not use forced or child labor. A draft of the law also showed that companies would be required to respect environmental standards, including the 1.5-degree warming target set by The Paris Climate Treaty.

The initiative would establish compliance and corrective measures in sync with some international conventions on human rights and environmental matters. In case of conflict, the other legislation would prevail. The Commission’s draft directive reflects the general consensus in the EU to work towards ESG (environmental, social and governance) goals.

Once the Proposed Directive is enforced, EU companies will be required to ensure that their suppliers, including direct and indirect established business relationships, both upstream and downstream, — regardless of location — are not using forced labor, child labor, or exploiting workers in any way. Global suppliers must also not commit environmental offenses related to greenhouse gas emissions, pollution, or biodiversity loss, and ecosystem degradation.

The proposal would require direct action from EU-based companies, their boards, and C-suite levels. The rules would apply to EU companies with more than 500 employees and a worldwide net turnover of more than 150 million Euros annually. 

For companies in high-impact industries like textiles, agriculture, forestry, fisheries, the manufacture of food products, construction materials, chemicals, and mineral resources (including oil, gas, and coal), the threshold is lowered. Rules then apply to high-impact sector companies with 250 employees and 40 million Euros turnover. 

The rules would also apply to approximately 4,000 companies that are based outside of the EU but operate inside the 27-nation bloc. The Proposed Directive applies to third-country companies with an annual 150 million Euros net turnover or high-impact sector companies with 40 million Euros turnover.

The proposal estimates it would apply to 13,000 EU companies, but 99% of Europe’s companies will be exempt from the rules, as they would not meet the noted thresholds.

Governments within the European Union will be tasked with monitoring companies operating within their borders. EU firms that do not comply will face fines, but companies may also face civil liability if the offense against human rights or the environment was committed by its supplier and it can be proven that the company has offered frequent cooperation and that the violation (s) could have been foreseen, prevented, ceased of mitigated with appropriate due diligence.

"It will in practice be difficult to prevent all risks through global value chains," the Commission draft said.

The Directive on Corporate Sustainability Due Diligence is the first of its kind proposed by the Commission. If passed, it will impose far-reaching penalties for companies that do not comply. 

The proposal will first be examined by European Parliament, and a debate about amendments is expected to follow. If the directive is adopted, EU Member States will need to enact implementing legislation regarding large companies within two years, but they will have an additional two years for obligations relating to the smaller “high risk” companies.

Covered companies are expected to incur added costs for establishing and operating due diligence processes. They may also incur transition costs from investments needed to change their operations and value chains to address adverse impacts.

The Commission admits that full compliance will be difficult, but some within the EU are applauding the effort. "It will in practice be difficult to prevent all risks through global value chains," the Commission draft said.

"Based on what we know, this is a massive step in the right direction in the fight against corporate abuse," said Aurelie Skrobik, Corporate Accountability Campaigner at Global Witness.

"This said, we need to ensure that the law holds companies liable for harms throughout their supply chains and that there are no loopholes. There should be no ambiguity in the final text - victims must be able to seek justice through EU courts," she said.

The Directive on Corporate Sustainability Due Diligence was not the only recent development in the EU ESG space. In February 2022, the Commission also published its Communication on Decent Work Worldwide which promotes work in global value chains and reaffirms the EU’s commitment to ending child labor and forced labor. 

Later that same week, the EU Platform on Sustainable Finance published its Final Report for the development of a social taxonomy and included a definition of “social” investment.”

The report builds on three proposed objectives – decent work (with links to value chain workers), Adequate living standards, and well-being for end-users, and inclusive and sustainable communities and societies.