Corporations have frequently struggled to grasp what it means to incorporate environmental, social and governance (ESG) considerations throughout their value chains. Yet, for corporations with operations in the European Union (EU), they will soon have to put their policies into practice when it comes to corporate due diligence and accountability.
In September 2020, the European Commission initiated a public consultation that asked shareholders to weigh in on a possible corporate due diligence initiative. This initiative would charge businesses with incorporating ESG interests into their operational strategies.
Following the consultation, the European Parliament produced draft legislation that detailed due diligence requirements for corporations. This new directive clarifies the steps organizations must take to mitigate the impact of their operations.
In a new white paper, Diligent’s partners Steele and Ezekiel Ward, founder of North Star Compliance Ltd., wrote about the draft directive’s implications.
“In the course of my work, I have seen my share of challenging human rights situations. These have left me in no doubt that there’s a moral obligation to address ESG issues, and especially human rights abuses, in corporate value chains.”
-Ezekiel Ward, founder of North Star Compliance Ltd.
Key takeaways from the white paper follow, which detail the scope of the directive, Ward’s recommendations for making your organization compliant, and when you can expect the European Commission to ratify the directive.
1. The Directive Is Not Just For EU-Headquartered Organizations
Though this directive comes from the EU, it will likely have a ripple effect around the globe, as any company that operates in the EU will need to comply. Compliance is mandatory even if headquarters are elsewhere.
“The draft directive includes all ‘undertakings’ governed by the law of a member state or established in EU territory,” Ward wrote. “In other words, any firm active on the EU market will need to comply.”
2. Corporations Will Have to Ensure Compliance Through the Entire Value Chain
It’s not enough for businesses to evaluate and make compliant their direct areas of oversight. The EU’s draft directive is expansive and calls for businesses to ensure their entire value chain is compliant. This includes subsidiaries, suppliers, partners, customers, third parties and more.
“The clear inclusion of direct and indirect relationships will be welcomed by some — companies often struggle where to draw a line,” Ward wrote. “But there will be situations where one genuinely cannot know the full extent of the value chain.”
Though these situations can make it challenging for corporations to thoroughly enact due diligence, Ward recommends a simple rule of thumb: If an organization does not know who is in their value chain, a risk exists. In other words, if companies don’t know the next supplier in the chain or have doubts about the origins of a good or service, they must obtain and disclose that information.
3. Existing Due Diligence Practices Might Not Meet the New Standard
Most organizations have a due diligence setup in place. Ward still recommends that organizations take a closer look at their current practices and whether or not they truly meet the EU’s new standard.
The directive covers a broad range of ESG issues that existing due diligence processes might not address. These issues include human rights, social and labor rights, and environmental impacts — essentially the entire ESG spectrum.
“That includes topics like integrity and corruption, so whatever current [due diligence] setup you have in place, it may need ‘lifting’ or re-positioning to meet the draft directive’s requirements,” Ward wrote.
4. Companies Should Expect a Due Diligence Requirement to Take Effect in 2023
Ward wrote that he expects the final requirement to be very similar to the draft.
“The fact that the EU Parliament issued a draft is, in itself, unusual,” Ward wrote. “It implies consensus and momentum among EU institutions.”
Germany passed their own due diligence legislation in March 2021. To remain competitive throughout the EU, Ward expects that Germany will certainly push for the directive to be made final in the near future.
If the process for this draft directive follows that of the EU Whistleblower Directive, compliance will likely be enforced within the next two to three years. That would establish a finalized requirement in 2023, which follows suit with Germany’s newly enacted timeline.
5. Boards Should Prepare Now for the New Due Diligence Standard
Organizations may have until 2023 to elevate their due diligence practices. But it will take time for corporations to evaluate and adapt their processes to meet the EU’s new standard. Boards should use the draft directive as a guide for reconstructing their accountability to ESG impacts.
In the white paper, Ward analyzes key articles from the EU’s directive and recommends eight actions boards can take now to ensure they’re compliant once the draft becomes law. Boards can begin by affirming their commitment to due diligence and ensuring that trickles down throughout their organization.
Large organizations should take the extra step of establishing an advisory committee or giving an existing committee oversight into the company’s due diligence. Boards should additionally run risk assessments, identify and resolve any oversights and aim to establish best-in-class policies and procedures in the area of due diligence.
“Assurance is advisable for large organizations, ensuring that the measures have been appropriately taken into the governance and management systems,” Ward wrote.
Heightened due diligence requirements are coming. Though they originate in the EU, they’ll impact organizations around the globe that operate in EU member states and territories. Organizations can begin their transformation now to ensure their due diligence policies and priorities satisfy the EU’s directive by 2023.
Download the white paper to learn more and for Ward’s full set of recommendations for establishing best-in-class due diligence practices in your organization.