COMMISSION STAFF WORKING DOCUMENT IMPACT ASSESSMENT REPORT Accompanying the document Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937

EN EN
EUROPEAN
COMMISSION
Brussels, 23.2.2022
SWD(2022) 42 final
COMMISSION STAFF WORKING DOCUMENT
IMPACT ASSESSMENT REPORT
Accompanying the document
Proposal for a
DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL
on Corporate Sustainability Due Diligence and amending Directive (EU) 2019/1937
{COM(2022) 71 final} - {SEC(2022) 95 final} - {SWD(2022) 38 final} -
{SWD(2022) 39 final} - {SWD(2022) 43 final}
Offentligt
KOM (2022) 0071 - SWD-dokument
Europaudvalget 2022
i
Table of contents
1. INTRODUCTION: POLITICAL AND LEGAL CONTEXT....................................... 1
1.1. How does this initiative contribute to the political priorities of the
Commission and the EU?.................................................................................... 1
1.2. What is the legal and policy context?.................................................................. 2
1.2.1. Companies, corporate governance and sustainability ............................. 2
1.2.2. Interlinked initiatives and added value.................................................... 3
1.3. Market context..................................................................................................... 5
2. PROBLEM DEFINITION ............................................................................................ 7
2.1. What are the problems?....................................................................................... 7
2.1.1. Short explanation of the problem ............................................................ 8
2.1.2. Sub-problem 1: Stakeholder-related (sustainability) risks to the
company and opportunities are not sufficiently addressed.................... 11
2.1.3. Sub-problem 2. Companies insufficiently address adverse impacts on
people and the environment in their own operations and value chains
in line with the EU’s human rights and environmental commitments .. 14
2.2. What are the problem drivers? .......................................................................... 16
2.2.1. Market Inefficiencies............................................................................. 16
2.2.2. Regulatory Inefficiencies....................................................................... 24
2.3. How will the problem evolve? .......................................................................... 29
3. WHY SHOULD THE EU ACT? ................................................................................ 30
3.1. Legal basis......................................................................................................... 30
3.2. Subsidiarity: Necessity and value added of EU action...................................... 30
3.2.1. The problems identified are European and to some extent global and
Member States cannot tackle them effectively at national level ........... 30
3.2.2. Companies and their investors operate and invest across borders,
value chains are increasingly European and even global, short-
termism is systemic ............................................................................... 31
3.2.3. Member States’ individual action leads to fragmentation and extra
costs....................................................................................................... 31
3.2.4. The EU has already regulated in this area............................................. 32
3.2.5. EU-level policy adds significant value for international action ............ 32
4. OBJECTIVES: WHAT IS TO BE ACHIEVED? ....................................................... 32
4.1. General objectives ............................................................................................. 32
4.2. Specific objectives............................................................................................. 33
5. WHAT ARE THE AVAILABLE POLICY OPTIONS? ............................................ 33
5.1. What is the baseline from which options are assessed? .................................... 33
5.1.1. Corporate due diligence......................................................................... 33
5.1.2. Directors’ duties .................................................................................... 36
5.1.3. Directors’ remuneration......................................................................... 37
5.2. Description of the policy options ...................................................................... 38
ii
5.2.1. Corporate due diligence requirement throughout the company’s own
operations and in the value chain .......................................................... 38
5.2.2. Directors’ Duties ................................................................................... 47
5.2.3. Directors’ remuneration......................................................................... 50
6. WHAT ARE THE IMPACTS OF THE POLICY OPTIONS?................................... 50
6.1. Corporate due diligence requirements throughout the company’s own
operations and in its value chains...................................................................... 52
6.1.1. Effectiveness.......................................................................................... 52
6.1.2. Costs ...................................................................................................... 56
6.1.3. Benefits for companies.......................................................................... 60
6.1.4. Environmental, social and fundamental rights impacts, and impacts
on the economy...................................................................................... 62
6.1.5. Impacts on third countries and developing countries............................ 63
6.1.6. Efficiency .............................................................................................. 64
6.1.7. Stakeholders’ views............................................................................... 67
6.1.8. Coherence.............................................................................................. 69
6.1.9. Proportionality....................................................................................... 69
6.2. Directors’ Duties ............................................................................................... 71
6.2.1. Effectiveness.......................................................................................... 71
6.2.2. Costs and other possible negative impacts on the company.................. 73
6.2.3. Benefits for companies.......................................................................... 77
6.2.4. Environmental, social and fundamental rights impacts, and impacts
on the economy...................................................................................... 78
6.2.5. Efficiency .............................................................................................. 79
6.2.6. Stakeholders’ views............................................................................... 82
6.2.7. Coherence.............................................................................................. 83
6.2.8. Proportionality....................................................................................... 84
6.3. Directors’ remuneration..................................................................................... 84
6.3.1. Effectiveness.......................................................................................... 84
6.3.2. Costs ...................................................................................................... 85
6.3.3. Benefits for companies, efficiency........................................................ 85
6.3.4. Environmental, social and fundamental rights impacts, and impacts to
the economy........................................................................................... 86
6.3.5. Coherence.............................................................................................. 86
6.3.6. Stakeholders’ views............................................................................... 86
6.3.7. Proportionality....................................................................................... 87
7. HOW DO THE OPTIONS COMPARE?.................................................................... 87
8. PREFERRED OPTION............................................................................................... 88
8.1. Combined impact preferred option.................................................................... 88
9. HOW WILL ACTUAL IMPACTS BE MONITORED AND
EVALUATED?........................................................................................................... 89
iii
Glossary
Term or acronym Meaning or definition
Limited Liability Companies
(LLCs)
Limited liability company means a company having
legal personality, possessing separate assets which alone
serve to cover its debts and that is subject, under the
national law governing it, to conditions concerning
guarantees for the protection of the interests of its
owners and third parties (e.g. the types of companies
listed under Annex II of the Company Law Directive
(EU) 2017/1132, of 14 June 2017, relating to certain
aspects of company law). The owners of limited liability
companies are shareholders or members, depending on
the legal form; the term “shareholders” is used in this
report as (also) referring to members, where relevant.
Directors Directors as defined by Article 3(i) of Directive
2007/36/EU, as amended by Directive (EU) 2017/828
(Shareholder Rights Directive) which encompasses
directors of the various national limited liability
company forms and the one and two-tier (dual) board
systems: (i) any member of the administrative,
management or supervisory bodies of a company; (ii)
where they are not members of the administrative,
management or supervisory bodies of a company, the
chief executive officer and, if such function exists in a
company, the deputy chief executive officer; (iii) where
so determined by a Member State, other persons who
perform functions similar to those performed under point
(i) or (ii).”
Where there is no board the person(s) entrusted with
managing the affairs of the company should be
considered director(s).
Supporting study on due
diligence
Study on due diligence requirements through the supply
chain, prepared for the European Commission by BIICL
and LSE, final report with annexes (February 2020)
Supporting study on directors’
duties
Study on directors’ duties and sustainable corporate
governance, prepared for the European Commission by
EY, final report with annexes (July 2020)
Open public consultation (OPC) The open public consultation conducted at the EU
Survey “Have your say” portal of the European
Commission between 26 October 2020 and 8 February
2021 to gather data and to collect the views of
stakeholders with regard to a possible initiative on
sustainable corporate governance.
ESG Environmental, Social and Governance
UN SDG United Nations’ Sustainable Development Goals. The 17
iv
SDGs are at the heart of the 2030 Agenda for
Sustainable Development, adopted by all United Nations
Member States in 2015.
UNGPs United Nations’ “Guiding Principles on Business and
Human Rights: Implementing the United Nations
‘Protect, Respect and Remedy’ Framework. The UNGPs
is an instrument consisting of 31 principles developed by
the Special Representative of the Secretary-General on
the issue of human rights and transnational corporations
and other business enterprises, and were endorsed by the
Human Rights Council in its resolution 17/4 of 16 June
2011.
(Corporate) due diligence Due diligence refers to the establishment and
implementation of adequate measures by a company
with a view to identifying, preventing and mitigating the
actual and potential (i.e. risk of) adverse impacts on
human rights (including labour rights)1
and the
environment (including the climate),2
in the company’s
own operations, its supply or value chains and adverse
impacts linked to the company’s products and services.
It is also called due diligence for responsible business
conduct3
; supply or value chain due diligence; corporate
due diligence for human rights and environmental
impacts; social, environmental and human rights due
diligence; or sustainability due diligence4
.
Value chain All activities, operations and business relationships of an
undertaking, including entities with which the
undertaking has a direct or indirect business relationship,
upstream and downstream and which either: (a) supply
products, parts of products or services that contribute to
the undertaking’s own products or services, or (b)
receive products or services from the undertaking.
For the purpose of this document, the notion of value
chain is broader than the term “supply chain” or
“upstream value chain” and encompasses it.
Downstream value chain includes parts of the life-cycle
of production which starts from the use phase and
includes the product end of life activities, such as
recycling, disposal of waste. Where sources cited in this
1
As provided for in the UNGPSs, GP 12 and OECD Due Diligence Guidance for Responsible Business
Conduct
2
As in the OECD Due Diligence Guidance for Responsible Business Conduct
3
See the OECD Guidance referred to above.
4
See Supporting study on due diligence, p. 59 and p. 156.
v
document use the term “supply chain”, this document
takes over this terminology.
Environmental impacts Environmental impacts are those specified in selected
international environmental conventions which contain
duties that are implementable for companies. For a list of
environmental harms covered in this initiative, please
refer to the list of human rights and environmental
agreements in Annex 17.
Human rights impacts Human rights impacts are understood as the violation of
human rights, contained in international conventions on
human rights, including labour rights. For a list of
human rights impacts, including labour rights, covered
in this initiative, please refer to the list of human rights
and environmental agreements in Annex 17.
Corporate science-based targets While the EU has set public targets on energy efficiency
and renewable energy for Member States, such targets
apply within the EU only and are largely limited to
public objectives. Translation of the EU’s Paris
commitment into corporate target setting as well would
ensure its achievement by industry. Corporate science-
based targets translate the 1.5°C goal into concrete
corporate action.
Stakeholders of a company Shareholders (members), employees, customers
(consumers and other businesses), suppliers and other
entities, people, groups, local communities, etc. affected
by the operation of the company, including employees
and others in its value chains, as well as the local and the
global environment (including the climate).
Shareholder Rights Directive
(SRD)
Directive 2007/36/EC on the exercise of certain rights of
shareholders in listed companies (SRD I), as amended,
among others, by Directive (EU) 2017/828 amending
Directive 2007/36/EC as regards the encouragement of
long-term shareholder engagement (SRD II)
Non-Financial Reporting
Directive (NFRD)
Directive 2014/95/EU amending Directive 2013/34/EU
as regards disclosure of non-financial and diversity
information by certain large undertakings and groups
Corporate Sustainability
Reporting Directive (CSRD) or
NFRD review
Commission Proposal for a Directive amending
Directive 2013/34/EU, Directive 2004/109/EC, Directive
2006/43/EC and Regulation (EU) No 537/2014, as
regards corporate sustainability reporting
Accounting Directive Directive 2013/34/EU on the annual financial
statements, consolidated financial statements and related
reports of certain types of undertakings, amending
Directive 2006/43/EC and repealing Council Directives
78/660/EEC and 83/349/EEC
vi
Capital Requirements Directive
(CRD)
Directive 2013/36/EU on access to the activity of credit
institutions and the prudential supervision of credit
institutions and investment firms, amending Directive
2002/87/EC and repealing Directives 2006/48/EC and
2006/49/EC (CRD IV), as amended, among others, by
Directive (EU) 2019/878 as regards exempted entities,
financial holding companies, mixed financial holding
companies, remuneration, supervisory measures and
powers and capital conservation measures (CRD V)
Capital Requirements
Regulation (CRR)
EU Regulation No 575/2013 of 26 June 2013 on
prudential requirements for credit institutions and
investment firms and amending Regulation (EU) No
648/2012
EFRAG European Financial Reporting Advisory Group
EBA European Banking Authority
CAPEX Capital Expenditure
CFP Corporate Financial Performance
GHG Greenhouse gases (greenhouse gas emission)
OECD Guidelines for
Multinational Enterprises
OECD MNE Guidelines are set of recommendations on
responsible business conduct addressed by governments
to multinational enterprises operating in or from the 49
adhering countries.
They provide non-binding principles and standards for
responsible business conduct in a global context that are
consistent with applicable laws and internationally
recognised standards. The implementation of the due
diligence recommendations in the OECD Guidelines for
Multinational Enterprises is supported by the OECD
Due Diligence Guidance for Responsible Business
Conduct and sector-specific due diligence guidance
developed by the OECD.
Midcaps There is no official or widely accepted definition of
'midcaps' at present. 'Midcaps' are deemed to be medium
capitalisation enterprises comprising 250 to 3000
employees (in full-time equivalents). They are divided
into 'small midcaps' of between 250 and 499 employees,
and 'medium and large midcaps' of from 500 to 3000
employees. For the purposes of this report two different
definitions are used to differentiate them from very large
companies, also defined in various ways.
1
1. INTRODUCTION: POLITICAL AND LEGAL CONTEXT
1.1. How does this initiative contribute to the political priorities of the
Commission and the EU?
The Union has set itself the objective of becoming climate-neutral by 20505
and to
deliver on the UN Sustainable Development Goals.6
Both these commitments require
changing the way in which we produce and consume. In its Communications on the
European Green Deal and on A Strong Social Europe for Just Transition, the
Commission committed to tackling climate and other environment-related challenges and
set the ambition to upgrade Europe’s social market economy to achieve a just transition
to sustainability.
As part of the European Green Deal, an initiative on sustainable corporate governance
was listed among the deliverables of the Action Plan on a Circular Economy, the
Biodiversity strategy, the Farm to Fork strategy and the Chemicals strategy and Updating
the 2020 New Industrial Strategy: Building a stronger Single Market for Europe’s
recovery. This initiative would build on the analytical and consultative work carried out
under Action 10 of the Commission’s 2018 Action Plan on Financing Sustainable
Growth7
, and contributes to the Strategy for Financing the Transition to a Sustainable
Economy.
Furthermore, the COVID-19 pandemic revealed vulnerabilities of global supply chains
for specific products and sectors which amplified adverse impacts on employment and
social conditions in the EU and in other parts of the world.8
Studies show that companies
which integrate the interests of their employees, affected parties and the environment into
corporate decisions performed better even during the pandemic.9
The COVID crisis
reinforced the emerging trend of calling for a paradigm shift towards a stronger focus on
long-term sustainability and highlighted the need to foster a resilient economy and
society.
The Communication “Europe's moment: Repair and Prepare for the Next Generation”
mentions sustainable corporate governance as an integral part of the efforts to achieve a
more resilient EU economy. It is against this background that the Commission’s 2021
work programme foresees the adoption of a legislative proposal on sustainable corporate
governance to foster long-term sustainable and responsible corporate behaviour.
5
“European Climate Law” (Regulation (EU) 2021/1119), together with a binding target to cut domestic net
GHG emissions by at least 55 % compared to 1990 levels by 2030: Article 2 “European Climate Law”.
6
The EU is committed to implementing the global 2030 Agenda and the 17 SDGs (see “Delivering on the
UN’s Sustainable Development Goals – A comprehensive approach”, SWD(2020) 400). Commission
Reflection Paper “Towards sustainable Europe 2030, (January 2019)
7
Following the 2018 recommendations of the High-Level Expert Group on Sustainable Finance.
8
See Annex 14 on specific related consequences of the Covid-19 crisis.
9
See Cheema-Fox et al., 2020, Corporate Resilience and Response During COVID-19; OECD Centre for
Responsible Business Conduct note “COVID 19 and Responsible Business Conduct”; European Capital
Markets Institute’s Commentary ESG resilience during the Covid crisis: Is green the new gold?, 67-2020.
2
Sustainability in corporate governance encompasses encouraging businesses to frame
decisions in terms of their environmental, health, and human rights impact, as well as in
terms of the company’s good performance and resilience in the longer term.
This initiative would contribute to reinforcing the respect of the environment and human
rights throughout value chains.10
Being a horizontal instrument applying also to the value
chain, it would complement other measures, existing or being prepared, which directly
address some specific sustainability challenges, mostly within the EU.11
This initiative also responds to two European Parliament reports calling on the
Commission to strengthen the dimension of sustainability in directors’ duties and to
propose EU rules for a comprehensive corporate due diligence obligation.12
1.2. What is the legal and policy context?
1.2.1. Companies, corporate governance and sustainability
The limited liability company – which this initiative focuses on – is the most used legal
form for organising major business activities in the EU. While encouraging risk taking
and innovation, creating a company as a legal entity separate from its founding owners
(and future shareholders or members) has always presented governance-related issues.
Corporate governance, encompassing decision-making structures, management processes
and the allocation of competences within the company, is important for providing proper
accountability and incentives to ensure adequate representation of the interests of
shareholders and other stakeholders in corporate decision-making. The debate on
corporate governance and EU initiatives have traditionally centred on addressing the
‘agency problem’ due to the separation of ownership and control, to ensure that directors
avoid decisions that serve their own interests instead of those of the owners of the
company and the company itself. Internal accountability mechanisms (e.g. shareholder
approval of certain decisions, strengthening shareholders’ participation rights,
shareholder say on directors’ pay, etc.) have been developed to align the interests of
shareholders and directors.13
Following the financial crisis of 2007-8, short-termism of
shareholders (including institutional investors) has been identified as contributing to
excessive short-term focus in corporate decisions (and to poor investment decisions in
10
Objective identified in the Joint Communication of the Commission and the High Representative on the
Global EU response to COVID-19. This initiative would also contribute to the EU’s agenda to promote
decent work worldwide, as referred to in the European Pillar of Social Rights Action Plan, the Council
Conclusions on Human Rights and Decent Work in Global Supply Chains, and to the EU Action Plan on
Human Rights and Democracy 2020-24. More specifically, the Trade Policy Review Communication
makes clear that forced labour should not find a place in value chains of EU companies.
11
See the list of such measures and a mapping of the added value of this initiative in Annex 7.
12
See European Parliament resolution of 17 December 2020 on sustainable corporate governance
(2020/2137(INI)) and European Parliament resolution of 10 March 2021 with recommendations to the
Commission on corporate due diligence and corporate accountability (2020/2129(INL)) .
13
See for example shareholder decisions in the context of takeovers in the Takeover Bids Directive,
shareholders’ voting rights and “say on pay” in the Shareholder Rights Directives (SRD I and II).
3
banks and other financial intermediaries); hence, the main aim of recent reform was to
foster long-term oriented shareholder engagement and to strengthen long-term
investment motives.14
The role of the company’s board is to protect the interests of shareholders, creditors,
employees and third parties by ensuring that the interests of the company are promoted
through risk management, strategy, supervision of the management and ensuring
compliance. The need for responsible business behaviour and for better considering the
interests of “stakeholders” (employees, other affected people, the environment, etc.) in
corporate strategies and decisions has gained importance, driven by an increased
materiality of intangible assets and of sustainability risks for the performance of the
company and by the need for the private sector’s contribution to addressing today’s
sustainability challenges.
1.2.2. Interlinked initiatives and added value
At EU level, sustainable corporate governance has so far been mainly fostered indirectly
by imposing reporting requirements on approx. 12 000 companies15
around
environmental, social and human rights related risks, impacts, measures (including due
diligence) and policies in the Non-Financial Reporting Directive (NFRD).16
The NFRD
had some positive impact but, given its limited scope in terms of companies, has not
resulted in mainstreaming a majority of companies taking stakeholder interests
sufficiently into account or managing sustainability risks and impacts.17
The recent
Commission proposal for a Corporate Sustainability Reporting Directive (CSRD,
revision of NFRD) extends the scope of the companies covered18
and strengthens the
standardisation of reported information. Similarly, the recent Taxonomy Regulation is a
transparency tool that helps facilitate investment decisions and tackle greenwashing by
providing a categorisation of environmentally sustainable economic activities with a
minimum social safeguard.19
Neither of these measures impose material duties on
companies other than public reporting requirements, and investors can use such
information when allocating capital to companies.
EU environmental law20
introduces various environmental requirements for companies,
Member States, or defines goals for the EU21
. However, it generally does not apply to the
14
E.g. the revision of the Shareholders’ Right Directive. More details in Annex 6.
15
Large public-interest entities that have more than 500 employees (and the balance sheet total or net
turnover of which exceeds the Accounting Directive’s threshold for large enterprises, see Section 1.3),
including listed companies, banks and insurance companies. Study on the NFRD.
16
See also, as explained above, some very limited new rules of the SRD II.
17
The Impact Assessment for the CSRD proposal and the study on the NFRD (section 2) found a limited
change in corporate policies as a result of the NFRD, consistent with the perception of main stakeholders
who could not identify a clear pattern of change in corporate behaviour driven by these reporting rules.
18
Sustainability reporting obligation for all large companies as defined by the Directive and, as of 2026, to
companies (including non-EU companies, excluding all micro enterprises) listed on EU regulated markets.
19
In the future, the taxonomy may contain a categorization of socially sustainable activities, too.
20
For further information please see Annex 7.
4
value chains outside the EU where up to 80-90% of the environmental harm may occur22
.
The most relevant interlinked initiative is the Environmental Liability Directive which
requires the prevention of some environmental harm in case of immediate threat of
damage and introduces the “polluter pays” principle. However, it has limited
application23
and does not cover the value chain. The Environmental Crime Directive
99/2008/EC which is currently under review24
provides for a set of definitions of what
constitutes environmental crime and obliges Member States to provide for effective,
dissuasive and proportionate sanctions.
EU climate legislation, including the recently proposed “Fit for 55” Package and its key
actions setting more ambitious energy efficiency and renewable energy targets for
Member States by 2030, needs to be underpinned by a wider transformation of
production (circularity, process efficiency, fuel-switching, etc.) and consumption
processes to achieve climate neutrality by 2050 across the economy and throughout value
chains. The “Fit for 55” Package will only indirectly apply to some non-EU value chains
of EU companies through the Carbon Border Adjustment Mechanism (CBAM) which
aims at preventing “carbon leakage”25
by imposing a carbon adjustment price for
imported products not subject to the carbon price deriving from the EU Emission Trading
System. In addition, not all climate impact throughout the value chain of the imported
product will be taken into account in the calculations under the CBAM.
Existing EU health and safety, and human rights legislation targets very specific
adverse impacts (such as privacy, discrimination, specific health aspects related to
dangerous substances, health and safety of workers, rights of the child, etc.) within the
EU26
but does not cover the entire plethora of human rights impacts and does not apply to
the value chain.
Existing or planned supply chain due diligence instruments at EU level apply to a
limited number of products: 4 minerals in the Conflict Minerals Regulation27
, timber and
timber products under the EU Timber Regulation28
(while new rules to minimise the risk
21
For example it introduces limitations on the release of some pollutants, defines EU goals (such as the
European Climate Law) or sets targets for Member States (such as for energy efficiency), defines
obligations for Member States (e.g. on protection of natural habitats), establishes minimum content in
authorisation procedures for some economic activities (e.g. Environmental Impact Assessment), etc.
22
See Starting at the source: Sustainability in supply chains (2016), Anne-Titia Bové and Steven Swartz.
23
Harm to land, water or protected species; for land and water limited to some sectors (energy, metals,
minerals, chemical, waste, large-scale pulp, paper, food production) and to large installations.
24
A Commission proposal is planned for 14 December 2021.
25
“Carbon leakage” resulting from the increased EU climate ambition could lead to increase total global
emissions. The CBAM carbon adjustment price on selected types of imported products in the iron steel,
aluminium, cement, electricity, fertilizers sectors would level the playing field between EU and imported
products.
26
Under EU law, every EU worker has certain minimum rights relating to protection against discrimination
based on sex, race, religion, age, disability and sexual orientation, labour law (part-time work, fixed-term
contracts, working hours, informing and consulting employees). See EUR-Lex for a summary.
27
Regulation (EU) 2017/821.
28
Regulation (EU) No 995/2010.
5
of deforestation and forest degradation would cover additional agricultural
commodities)29
, and 4 minerals used for electric vehicle and industrial batteries in the
Commission proposal for a new Batteries Regulation30
. These rules ensure the avoidance
of some clearly identified risks of adverse impacts in supply chains31
. The Sustainable
Products Initiative under development, aims to revise the current Ecodesign Directive
and concerns the sustainability of products placed on the EU market more broadly.
However, this initiative would only consider specific due diligence requirements with
respect to specific products, should there be the need for such rules in addition to the
present initiative.
The legislative framework for a Union sustainable food system under development aims
to make the EU food system sustainable and to integrate sustainability into all food-
related policies. Inclusion of sector specific due diligence requirements for food
companies will be explored.
Thus, the EU’s regulatory environment currently does not offer EU companies a
transparent and predictable framework that helps them to asses and manage sustainability
risks and impacts across all risk and impact areas and across their value chains as well.
For more detailed information about the mapping of interlinked existing and planned EU
law and information on the added value of this initiative, please refer to Annex 7.
1.3. Market context
There are about 13.7 million limited liability companies (LLCs)32
in the EU. 76 000
limited liability companies are large33. Looking at very large EU limited liability
companies more closely, and in view of the regulatory options analysed in this report,
about 23 200 companies have more than 500 employees or a turnover above
EUR 350 million, roughly 9 400 of LLCs have more than 500 employees and a
turnover above EUR 150 million, and about 8 900 LLC companies have more than
1000 employees.34
Furthermore, there are about 3 250 EU-based limited liability
companies that have shares listed in the EU.
29
Initiative on Deforestation and Forest Degradation: Beef, palm oil, soya, coffee, cocoa and wood.
30
Proposal for a Regulation concerning batteries and waste batteries (COM(2020) 798/3).
31
For example armed conflict and related serious human rights abuses in the Conflict Minerals Regulation
32
Due to the close links to the NFRD and its current revision (amending the Accounting Directive), we
rely here on the approximations for the number of companies that are considered as LLCs for the purposes
of the Accounting Directive. In particular, we rely on the data included in the 2020 Study on the NFRD,
both for the overall number and on the number of large LLCs.
33
According to the Accounting Directive, large undertakings are those that exceed at least two of the three
criteria: EUR 20 million balance sheet total, EUR 40 million net turnover, 250 employees.
34
These data are derived from the Orbis database and include all companies domiciled in the EU, classified
as public or private limited liability company in Orbis. Data are based on the most recent information
available for the filtering variables (number of employees, turnover, balance sheet total), which means that
occasionally figures for some companies may have been taken from earlier years.
6
According to the Commission’s proposal, the sustainability reporting obligations under
the Corporate Sustainability Reporting Directive would cover approximately 49 000
corporate groups (including all large companies and all EU and non-EU non-micro
companies that have securities listed in EU regulated markets).35
Given the limited data on the turnover of third-country companies, it is not possible to
estimate the number of third-country companies falling in the scope of this initiative.
For further detail, please refer to Annex 9.
35
See the NFRD study and the Commission’s impact assessment accompanying the CSRD proposal. This
figure takes into account the consolidated reporting requirement at group level. This represents
approximately 65 000 individual large companies and 1 400 listed SMEs.
7
2. PROBLEM DEFINITION
2.1. What are the problems?
The following problem tree gives an overview of the identified problems, their underlying causes and their consequences for the various stakeholders.
Problem:
Sustainability is not sufficiently integrated in corporate governance
Subproblem 1:
Stakeholder-related (sustainability) risks to the company and opportunities are
not sufficiently addressed in the best interest of the company
Consequences of subproblem 2:
Consequences of subproblem 1:
Drivers
Problems
Consequences
For the company:
risk of reputational
damage and litigation
exacerbated
For employees, including in the value chain, and
for affected people and entities:
inappropriate working conditions, lack of respect of
human rights, lack of access to remedy for
environmental and human rights violations
For the environment:
environmental degradation,
biodiversity loss, climate
change, etc. exacerbated
For society:
sustainability
transition withheld,
just transition
jeopardised
For third countries:
adverse human rights
and environmental
impacts
For the company:
limited ability to adapt to change; the company invests insufficiently in
innovation, development, human, intellectual, social and natural capital,
which weakens its productivity, financial performance, competitiveness,
resilience and viability over the longer run
For
employees:
insufficient
investment
into human
capital
For the economy:
negative impact on
long-term growth,
innovative capacity,
productivity and
resilience
For long-term
shareholders:
suboptimal investment
performance,
sustainability risks of
investment portfolios
exacerbated
Subproblem 2:
Companies insufficiently address adverse impacts on people and the environment in
their own operations and value chains in line with the EU s international environmental
and human rights commitments
Market inefficiencies:
Directors duties are
misinterpreted as requiring
short-term financial value
maximisation instead of creating
long-term value
Directors remuneration
incentivises a focus on
short-term (share price)
performance
Companies do not fully use stakeholder-related
(i.e. human, intellectual, social, natural) capital to
reach the social optimum because market signals
push directors to give priority to short-term
financial performance
Stakeholders voice
is not sufficiently
channelled into
corporate decisions
Companies lack sufficient
knowledge of their global value
chains, including risks and
dependencies related to these. They
lack tools to address sustainability
risks and to identify impacts.
Regulatory inefficiencies:
Emerging laws set diverging
corporate due diligence and
accountability requirements
Directors duty to act in the interest of
the company is often unclear,
company law and corporate
governance frameworks emphasise
accountability towards shareholders
Voluntary due diligence standards are
not effective to mainstream adequate
risk and impact management, they do
not provide for legal certainty and
many of them are not comprehensive
Company law lags behind the
emergence of global companies,
groups and value chains
Harmed persons face legal
barriers to hold companies to
account and get remedies
For investors and
consumers:
companies do not
provide reliable
information about
their possible risks and
adverse impacts
8
2.1.1. Short explanation of the problem
This section explains the problems, as well as the drivers, with Annex 10 providing
additional evidence.
The main problem addressed by this initiative is the need to reinforce sustainability in
corporate governance and management systems. There are (at least) two dimensions to
this problem: first, stakeholder interests and stakeholder-related (sustainability) risks to
the company which may materialize only in a longer time-frame are not sufficiently
taken into account in corporate risk management systems and decisions (sub-
problem 1). Intellectual, human, social and environmental capitals contribute in
important ways to a company’s long-term value, its resilience and external social and
environmental impacts also increasingly affect the performance of the company. A
failure to properly manage those dependencies and related risks (for example by
protecting the quality of the soil on which the company depends, by training employees,
or by adapting to climate change) may lead to suboptimal performance of the company,
in particular, in the medium to longer term36
. There may be similar consequences of
neglecting stakeholder interests in management of the company, and consequently
diminishing opportunities related to the sustainability transition37
. Such opportunities
arise for example from savings, resource efficiencies, better productivity linked to
“nature positive” production processes, innovations leading to seizing sustainable
product markets, investing into human capital, etc. This is the internal dimension of
sustainable corporate governance, and it is primarily about the sustained performance
of the company itself.
Secondly, companies do not sufficiently mitigate their adverse human rights and
environmental impacts in line with the EU’s international environmental and human
rights commitments (sub-problem 2), and do not have adequate governance,
management systems and measures to mitigate their harmful impacts. This is the
external dimension of sustainable corporate governance, and it is primarily about
adverse impacts on others and the planet (so called inside-out impacts of the company).
External impacts and internal risks and opportunities are strongly interlinked. External
impacts, if unaddressed, can create reputational, litigation, operational or other risks,
thereby affecting the performance of the company itself in the short, medium or long-
term. Therefore, in practice, impact mitigation (due diligence) processes, where they are
36
The reasons why companies do not address these issues are explained further in this section.
37
The World Economic Forum’s Future of Nature and Business report identifies annual business
opportunities linked to the sustainability transition worth $10 trillion in some sectors only that could create
395 million jobs by 2030.
9
in place, are often part of the company’s risk management systems. In the same vein,
addressing negative externalities may result in opportunities38
.
The drivers of these sub-problems are a combination of market and regulatory
failures. As regards market failures, competitive pressure makes companies apply
purchasing practices which prioritise short-term cost reductions. This may also lead to
outsourcing parts of a company’s production through global value chains located in third
countries with often low human and labour rights or environmental standards, thus
contributing indirectly to violations of human rights and to environmental degradation.39
Another well-documented pressure takes the form of short-termism of investors40
. The
best known example is the case of shareholders of companies listed on a public stock
exchange but short-termism can also be found with bondholders and, to a lesser extent,
shareholders in non-listed companies. Such pressures can also contribute to companies
overlooking their external adverse impacts, disregarding longer-term sustainability risks
and foregoing investments into the long-term sustainability and resilience of the
company, including into new technologies, employees, and future-proof production
processes. Partly as a response to such pressures, and often reinforced by the incentives
built in their remuneration schemes, corporate directors tend to interpret their duties
vis-a-vis the company as requiring a focus on short-term financial performance41.
Also, companies may not manage their stakeholder-related risks because of a perceived
lack of business case42
or of awareness (due to the absence of market standards on risk
management, or because risks arising in complex value chains are difficult and costly to
identify, etc.).
38
The concept of “sustainability” is wider for the internal dimension than for the external dimension: while
the external dimension captures human rights and environmental harm, risks to the company related to
stakeholders may also arise, for instance, from insufficient human or natural capital development (e.g.
failure to develop certain expertise of workers that would be key for the company).
39
See Supporting study on due diligence, p. 214-217.
40
For an analysis on short-termism of institutional investors and asset managers, see Kay review. For
frequent portfolio turnover and short-term shareholding periods of “long-only” investors, see Mercer,
IRRC Institute 2010, Do managers do what they say? For short-termism in banking, see EBA report on
undue short-term pressure from the financial sector on corporations, 2019, finding that banks’ average 3- to
5-year horizon for business planning and strategy-setting hampers longer term strategies and activities and
does not allow long-term and sustainability challenges to be fully taken into account.
41
See for example the SMART Research Reports - SMART (uio.no) financed by Horizon 2020:
42
Supporting study on directors’ duties. In addition to short termism, there are at least two other distinct
mechanisms in economic literature that explain suboptimal outcomes in such context: 1) uncertainty about
product quality (see Stiglitz 1979): in a model of costly search, depending mainly on the expected
frequency of the (returning) customer, a firm finds it optimal to invest into transparency about the quality
of its products or, alternatively, to increase the opacity. Product quality in the present context will include
the firms’ efforts to manage human rights and environmental risks; 2) poverty traps (see Capra et al 2009):
a socially preferred outcome cannot be reached due to lack of (external) commitment mechanisms.
10
Finally, weak corporate governance amplifies agency problems within corporations43
.
Furthermore, as other stakeholders’ voice is not sufficiently channelled into corporate
governance44
, capitals (intellectual, human, social and environmental) linked to such
stakeholders, may not be sufficiently protected or developed.
As regards regulatory failures, corporate regulation, corporate governance frameworks
and accountability mechanisms focus on financial performance and emphasise
accountability towards members/shareholders. The law is often unclear about whether
and how broader stakeholder interests have to be taken into account in directors’
decisions, i.e. when decisions are being made in the interest of the company.
International policy frameworks and voluntary standards on mitigating adverse external
impacts45
exist46
but they do not fully reflect the EU’s human rights and environmental
commitments and do not mainstream proper impact management. Furthermore, because
of their non-mandatory nature and guidance-like language, they do not provide legal
certainty for businesses47
and cannot be expected to counter market pressure to reduce
operating costs.
Sub-problem 2 is also caused by the fact that company law is lagging behind the
emergence of global value chains where factual control can be exercised, similarly to
corporate ownership in groups, but through contracts or financing. Through its
purchasing decision, the company can control the quality of the product or service in
terms of related externalities and through the contract itself it can attempt to impose
certain human rights and environmental criteria, even beyond direct contractors.
Emerging EU and national laws on corporate due diligence diverge48
, creating a risk
of fragmentation and emergence of barriers for the EU single market, thus un-levelling
the playing field and raising additional administrative burden and costs for companies
based in different Member States. Finally, despite the grievance mechanisms established
by countries adhering to the OECD Guidelines for Multinational Enterprises49
, victims
do not have a legal instrument to claim access to remedy if an EU company is
associated with harm in its value chain.
43
For instance directors’ acting against the long-term value of the company, e.g. by exploiting their
information advantage vis-à-vis shareholders about investment opportunities.
44
See under section “What are the problem drivers?”
45
Please see a list of examples of such standards on the International Trade Centre’s (ITC) Standards Map.
46
See e.g. International Trade Centre (ITC) The Standards Map project.
47
Results of the public consultation show that while the majority of companies indicated that they have
experience with voluntary measures (47.1%) or legal obligations (24.6%), only 1 in 4 considered the
existing voluntary frameworks to be sufficient. Businesses complain about the voluntary nature of the
regulatory framework contributing to legal uncertainties. A growing number of companies are being sued
in court for causing harm, which may be the consequence of the lack of clear regulatory requirements.
Emerging jurisprudence suggests companies’ legal responsibility to mitigate harm in line with international
agreements (such as the Paris agreement in Milieudefensie v. Shell of 26 May 2021).
48
See section 2.2.2.4
49
Requirement for governments to set up a National Contact Point contributing to the resolution of
complaints against companies that may arise from the alleged non-observance of the guidelines in specific
instances.
11
As regards consequences, sub-problem 1 leads to insufficient ability of companies to
adapt to change and to insufficient investment in development, innovation, human and
natural capital, jeopardising the long-term productivity, competitiveness and resilience of
the company, to a suboptimal return for members and shareholders50
. Eventually, it will
hamper the economy’s innovative capacity, productivity, growth potential and resilience,
including its long-term competitiveness. Sub-problem 2 has negative impact on affected
people, exacerbates biodiversity loss, environmental degradation and climate change.
Both sub-problems result in companies not being able to disclose fully reliable
information about their risks and impacts to shareholders and consumers as the
underlying risk and impact management systems are not sufficiently developed. Both
sub-problems slow down the sustainability transition51
and jeopardise a fair transition.
2.1.2. Sub-problem 1: Stakeholder-related (sustainability) risks to the company
and opportunities are not sufficiently addressed
A company’s performance depends to a large extent on how it manages its stores of
value, including financial capital, intellectual and human capital, social and relationship
capital, and natural capital. These can be associated with some of the companies’
stakeholders, such as employees, other affected people, or the environment52
. All
companies rely on all these stores of value to an extent53
, but dependencies may vary by
sector or type of activity, location, in time, etc.
Companies’ operations and assets may be affected by external sustainability factors as
well54
. Similarly, repercussions from the cumulative adverse impacts of economic
activity and industrialisation on the environment and society also affect individual
companies, deteriorating their operating environment and increasing their sustainability
risks55
. Risk to the company can also arise from not addressing its own adverse
50
Sub-problem 2 may also contribute to such consequence on the performance of the company.
51
For instance, the restrained innovative capacity and insufficient contribution of companies to closing the
investment gap hold up the accomplishment of the sustainability transition. According to McKinsey &
Company, “How the European Union could achieve net-zero emissions at net-zero cost?” (December
2020), reaching the 2050 net-zero emission target alone would require a total capital expenditure of around
EUR 1 trillion per year in the EU27 in the period 2021-2050.
52
When asked about interests relevant for the company’s long-term success and resilience, overall
respondents to the public consultation highlighted: 1) interest of employees, 2) interest of customers, 3)
interest of natural environment including climate change, 4) interests of people and communities affected
by the company’s operations, 5) shareholders’ interest and 6) consequences of any decision in the long-
term (beyond 3-5 years). See also Annex 2.
53
For instance, intellectual capital became the most important asset in the knowledge based economy. The
IBEPS Global Assessment Report on Biodiversity and Ecosystem Services (2019) shows that 50% of
global GDP is strongly or moderately dependent on nature.
54
For example, a company not preparing its workforce for the digital transformation, an SME supplier of a
car manufacturer disregarding the buyer’s transition towards electric cars, a company not taking steps to
adapt to climate change and environmental degradation while these impact its operations.
55
The individual contribution can be tangible. For instance, in Milieudefensie v. Shell, Shell’s activities
and products were found responsible for about 1% of global emissions every year.
12
impacts on others or the environment, including in the form of exposure to litigation56
or reputational damage57
.
Companies not properly managing such dependencies and risks face challenges to
their sustained performance and resilience. For instance58
, climate change-related risks
comprise physical risks and transition risks. Biodiversity loss is associated with
transition, liability, and physical risks, other environmental risks, such as water-
related risks are also relevant.
Finally, if a company does not develop its human capital appropriately, it will face the
risk of not being able to respond to the rapidly changing business environment, while
human rights, labour and social issues (poor workplace safety, employment of forced or
child labour, etc.) also create risks to the company.
Stakeholder-related risks, including employee-related and environmental risks can also
arise for the company from its value chains. Sustainability-related value chain
disruptions may affect the entire operation of a company. Exposure to sustainability
risks through the value chain is significant as many value chains are geographically
highly concentrated in areas where sustainability impacts are even more likely.59
As regards the magnitude of the problem, sustainability risks have become more
material for the success of companies in the light of globalisation, climate change,
increasing environmental degradation, the resulting scarcity of resources, and growing
inequality.60
Environmental risks are already rated among the ones with the highest
likelihood and highest impact risks to businesses, with human-made environmental
damage perceived as posing an imminent threat61
, and based on scientific forecasts,
climate change presents increased risks already in the short run.62
Reputational risks are
also increasing as consumer preference continues to shift towards sustainable products.63
56
In Milieudefensie v. Shell, the company was ordered to cut the carbon emissions of its global value
chains – including suppliers and products and services – in line with the Paris Agreement.
57
For instance, in BP’s Deepwater Horizon 2010 oil spill, the FT estimates that the clean-up costs alone
may have amounted to USD 90 billion. The company suffered also from a reputational perspective.
58
For more details on the different types of risks see Annex 10, point 1.
59
For example, semiconductor chips and rare earths. For more details see Annex 10, point 1.
60
The Bank of England shows that global economic losses from extreme weather events have been
constantly increasing, see Climate change: why it matters to the Bank of England? and Climate change:
what are the risks to financial stability? . See also Shining a light on climate risks: the ECB’s economy-
wide climate stress test (2021).
61
See The Global Risk Report 2021 referred to above.
62
The IPCC Special Report 2018 finds that every year’s delay before initiating emission reductions
decreases the available time to reach zero emissions on a pathway remaining below 1.5°C by
approximately two years. The World Meteorological Organization’s Global Annual to Decadal Climate
Update forecasts increased temperatures until 2025 in almost all regions of the world, with more rain or
tropical cyclones in certain regions. This increases physical risks to companies related to climate change.
63
Wilson J., Consumer preferences continue to shift towards sustainability, market research shows.
TriplePundit, November 2018. See also the study on EU market for sustainable products, the retail
perspective on sourcing policies and consumer demand.
13
Supply chain disruptions had been widespread before the COVID-19 pandemic, but
they have become even more pronounced since then and are expected to increase
further64
. The crisis revealed also strategic dependencies that affect EU companies.65
Industry plays a key role – through its corporate policies and decisions – in improving
resilience and reduce any dependencies that may lead to vulnerabilities, including
through diversification of suppliers, increased use of secondary raw materials and
substitution with other input materials.66
With increasing interest of investors in sustainable investment opportunities, disregarding
sustainability considerations in corporate strategies can also prevent companies from
attracting investments.67
Some risks affect some sectors more than others, and some Member States may be
more exposed to some risks68
. Other risks may affect all parts of Europe (SME
subcontractors lagging behind the gradual transformation towards climate-friendly
production of the buyer).
Companies show different maturity in the management of stakeholder-related risks,
impacts and opportunities. In general, the risk management does not adequately address
sustainability matters.69
Furthermore, there is little evidence that companies are managing sustainability risks
when valuing assets, notably that they take risks resulting from decarbonisation or the
physical impacts from climate change into account as they draw up their financial
statements.70
This is despite the fact that the stock of existing assets is at risk because of
climate change is large.71
Among EU companies which have to report to the public based
on the NFRD72
(including large listed companies), only 20-25% of companies provide
specific information related to their environmental, climate and human risks and 11%
explain the opportunities linked to sustainability challenges. Less than 6 % provide
information related to different time horizons and around 11% provide information
related to supply chain risks. Only 14% report that the board has oversight over
environmental and human rights matters. The CSRD proposal aims to address these gaps,
64
The Business Costs of Supply Chain Disruption – GEP (economist.com)
65
EU Strategic dependencies analysis accompanying the Commission’s Communication “Updating the
2020 New Industrial Strategy: Building a stronger Single Market for Europe`s recovery”, May 2021.
66
OECD analysis has confirmed that global value chains maximize economic efficiency, and that resilient,
supply chains are essential in times of crisis to absorb shocks, to offer options to adjust and to speed up
recovery. Cf. Shocks, risks and global value chains: insights from the OECD METRO model, June 2020.
67
See e.g. Global Sustainable Fund Flows – 4 2020, January 2021 Morningstar
68
For examples of more affected sectors and Member States see Annex 10, point 1.
69
See World Business Council for Sustainable Development on “Sustainability and enterprise risk
management” (2017) according to which 80% of risk management and sustainability practitioners say risk
management does not adequately address sustainability risks.
70
See Institutional Investors Group on Climate Change Investor Expectations for Paris-aligned Accounts
(2020).
71
See Commission SWD “Closing the climate protection gap - scoping policy and data gaps”, May 2021
72
See The Alliance for Corporate Transparency Research Report 2019 on 1000 companies across sectors.
14
but they also point to underlying weaknesses in company management of sustainability
risks and impacts.
As regards specifically the actual and potential impacts of climate-related risks and
opportunities on the company’s businesses, strategy, and financial planning, large
companies’ disclosure remains below 50%73
. While several large companies are
frontrunners, most corporate strategies are rarely elaborated with sustainability
objectives based on proper measurement.74,75
30% of the companies reviewed report
that they integrate climate change risks into their risk management processes. The
market is even less advanced on other environmental risks76
.
There are some differences in the corporate sustainability reporting practices across
European regions77
, sizes of companies78,79
and sectors.80
2.1.3. Sub-problem 2. Companies insufficiently address adverse impacts on
people and the environment in their own operations and value chains in
line with the EU’s human rights and environmental commitments
Corporate due diligence is a management tool to identify and mitigate the company’s
actual and potential adverse impacts and related risks in their own operations and value
chains in terms of human rights violations (including labour rights) and environmental
harm. The concept of due diligence for human rights impacts was developed in the
United Nations Guiding Principles on Business and Human Rights (“the UNGPs”)
and in the OECD Guidelines for Multinational Enterprises, related Guidance on
Responsible Business Conduct and sectoral guidance and further embedded in the
recommendations of ILO Tripartite Declaration of Principles concerning Multinational
Enterprises and Social Policy.81
The OECD framework extended the application of due
diligence to cover environmental harm. In the last decades, voluntary standards have
73
See TCFD’s 2020 Status Report examining 1700 large companies’ disclosures. For more details see
Annex 10, point 2.
74
See the TCFD’s 2020 Status Report, referred to above, for more details refer to Annex 10, point 2.
75
86% of respondents to the public consultation believe sustainability risks, impacts and opportunities
should be integrated into a company’s strategy, decisions and oversight. Individual companies and business
associations expressed support with 70.6% and NGOs with 92.4%.
76
See 2019 Research Report of the Alliance for Corporate Transparency, referred to above.
77
See the 2020 Research Report of the Alliance for Corporate Transparency for regional differences, for
more details see Annex 10, point 2.
78
See the TCFD’s 2020 Status Report, referred to above, for details see Annex 10, point 2.
79
In the Global Reporting Initiative’s Sustainability Disclosure Database only between 10-15% of all
sustainability reports in 2017-18 came from SMEs. Literature shows that most SMEs have been slow to
adopt environment-related improvements in the EU. See the report on SMEs and the Environment in the
European Union (Calogirou et al. 2010). For more details see Annex 10, point 2.
80
See 2019 Research Report of the Alliance for Corporate Transparency, for details see Annex 10, point 2.
81
See ILO Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy
15
been developed on supply chain due diligence and progress has been made by voluntary
business action82
.
Some companies have integrated sustainability into their decisions as this can provide
them with a competitive advantage.83
This also responds to the increasing consumer
pressure.84
However, more companies could implement comprehensive human rights
and environmental impact mitigation processes through their entire supply or value
chains, taking into account the relevance of most of these matters across a large number
of sectors:85
 Among larger EU companies, around 33% claim that they undertake
voluntary due diligence which takes into account all human rights and
environmental impacts, and 16% cover the entire value chain. SMEs perform
due diligence to an even lesser extent, as most of them source locally, their
general awareness on human rights is low, and their human and financial
resources they can dedicate to due diligence are also more limited.86
For more
details on uptake of due diligence by EU companies see annex 10.
 From among those companies that do, many do not practice due diligence in a
sufficiently comprehensive way87
, voluntarily reflecting the EU’s human rights
and environmental commitments and international standards.88
While 36 % of
large companies report on climate targets, 14% of them adopt science-based
targets when it comes to climate change and the goal of the Paris agreement to
limit it to 1.5°C.89
35 % of these meet their emission reduction targets90
.
82
Examples include the Accord on Fire and Building Safety in Bangladesh (see P. M. Barrett, D.
Baumann-Pauly and A. Gu (2018): Five Years After Rana Plaza-The Way Forward) and the 2016 initiative
to improve labour rights in Myanmar. For more, see International Trade Centre (ITC): The Standards Map
project and the Supporting study on due diligence (Table 8.8, p. 336).
83
E.g. EU Code of Conduct on Responsible Food Business and Marketing Practices under the F2F Strategy
that entered into force on 5 July 2021. For more initiatives see the Supporting study on due diligence.
84
See e.g. M. White (2018), The conscious consumer; K. Haller, J. Lee, J. Cheung (2020), “Meet the 2020
consumers driving change”; or Deloitte’s 2021 survey among UK consumers “Shifting sands: Are
consumers still embracing sustainability?”.
85
See materiality matrix in The Alliance for Corporate Transparency Research Report 2019.
86
“Uptake of CSR by European SMEs and start-ups”. (EASME/2020/OP/0004) - Draft final report
87
Research has shown that corporations that adopt internal carbon footprint policies often pay less
attention to human rights risk management. See D. S Olawayi, The Human Rights-Based Approach to
Carbon Finance (2016); C. Macchi, The Climate Change Dimension of Business and Human Rights: The
Gradual Consolidation of a Concept of “Climate Due Diligence”,(2020).
88
Multiple sources confirm this. For example Corporate Human Rights Benchmark (2020): Measuring 230
global companies on their human rights performance; Alliance for Corporate Transparency (2019):
Research Report on companies’ sustainability disclosures; European Parliament (2020): Corporate due
diligence and corporate accountability - European added value assessment; OECD (2021), Costs and Value
of Due Diligence in Mineral Supply Chains.
89
See The Alliance for Corporate Transparency Research Report 2019. Data from EcoVadis’ rating
responses (over 65 000 companies) reveal that about 3.5% of large companies issued SBTs in their 2019
assessments. See Ecovadis: Corporate Action on Greenhouse Gas Emissions (September 2020).
90
See The Science Based Targets Initiative Annual Progress Report 2020. In 2019-2020, among those
primarily large listed EU companies in high carbon sectors which have set targets, 35% achieved emissions
16
Corporate climate targets are often aspirational and rarely accompanied with
proper asset allocation and investment91
.
 Only a few companies seem to reflect quality criteria for due diligence92
and
report on the outcomes of their environmental and human rights policies93
.
Certain EU companies have been associated with adverse human rights and
environmental impacts, including in their value chains94
and voluntary action does not
appear to have resulted in improvements in some sectors95
. Adverse impacts include in
particular human rights issues such as forced labour, child labour, inadequate workplace
health and safety, exploitation of workers, and environmental impacts such as GHG
emissions, pollution, biodiversity loss. Examples of EU companies’ association with
adverse human rights and environmental impacts are included in Annex 10.
2.2. What are the problem drivers?
2.2.1. Market Inefficiencies
2.2.1.1.Companies do not fully use stakeholder-related (human, intellectual,
social, natural) capital to reach the social optimum because market
signals push directors to give priority to short-term financial
performance
According to the theory of the firm96
, where incomplete markets create profit
opportunities97
, companies aggravate the negative consequences of missing markets via
their normal business operations.
reductions in line with the target, suggesting that targets were either very recent, ineffective to drive
emissions reductions or ignored by the company. Out of 1726 companies 6% has a climate science-based
target. For biodiversity or water, target setting is even more limited than for climate change.
91
None of the EU companies assessed by the investor organisation Climate Action 100+ has appropriate
capital allocation aligned with the objective of limiting global warming to 1.5°C See 2020 Progress Report.
92
For instance, only 3.6% companies report any information on the effectiveness of the policies adopted to
address their identified human rights risk. Corporate Human Rights Benchmark (2020): Measuring 230
global companies on their human rights performance; Alliance for Corporate Transparency (2019):
Research Report on companies’ sustainability disclosures. R. McCorquodale, L. Smit, R. Brooks and S.
Neely “Human Rights Due Diligence in Law and Practice: Good Practices and Challenges for Business
Enterprises” (2017) found that nearly 80% of companies that used dedicated due diligence processes do
identify adverse impacts, whereas 80 % of companies using non-specific due diligence do not.
93
28% of 1000 EU companies report on the outcomes of their climate policies, 3% of their biodiversity
policies and 6% of human rights policies. The Alliance for Corporate Transparency Research Report 2019
94
Study on due diligence (2021), p. 221 indicates no change in corporate risk assessment processes which
focus on the materiality of the risks to the company, despite international guidance (UNGP, OECD) which
clarifies that the relevant risks must extend beyond the risks of the company to those who are affected (the
rights-holders). Negative corporate impacts as a consequence of globalisation and failure to undertake due
diligence, ranging from environmental disasters and land grabbing to serious violations of labour and
human rights, are well documented.
95
Evidence clearly shows that a voluntary approach did not suffice to mainstream companies’
implementation of comprehensive human rights and environmental impact mitigation processes, see
Annex 10 and section on problem drivers.
96
R .H. Coase in the “The Theory of the firm”, 1937.
17
At the same time, companies are severely impacted by the incompleteness of markets in
their daily operations and their investment decisions, for example because of lack of
information. In a competitive market environment, most entrepreneurs will know realized
prices for goods and services sold, and entrepreneurs will know their own costs of
production. The only certain way to improve financial performance consists in reducing
those costs. This is the competitive pressure most firms are facing on a daily basis.
In addition, a firm will try to gain at least temporary pricing power and increase its profit
opportunities by developing innovative products98
and services or upgrading its
production processes with the right investment decisions. For this, most companies put
aside some of their earnings (retained earnings). If retained earnings are not sufficient,
other sources are used (bank loans, corporate bonds or new share issuance).
For both challenges, the daily competitive pressure and the choice of the best project
investment, companies struggle to manage the increasing risks related to the environment
and the protection of social and humanitarian achievements. Markets for trading those
risks typically do not exist, or are in an embryonic state of development.99
Investments
into more sustainable production processes may go against short-term liquidity
constraints and their outcome may be regarded as uncertain even though they have a
potential to significantly enhance long-term value and improve profitability. In the
absence of legally binding requirements, firms have difficulty to argue in favour of better
funded internal risk management processes as well as longer-term investments.
Market prices not adequately reflecting negative externalities also demonstrates this
market failure. As regards environmental externalities for example, between 1992 and
2014 the value of produced capital (such as machines and buildings) roughly doubled and
that of human capital (workers and their skills) rose by 13%, while the estimated value of
natural capital declined by nearly 40%100
. The demands that the economy currently
places on nature are roughly equivalent to the sustainable output of 1.6 Earths and is
97
E.g. because the use of ecosystem services is not properly accounted for, or because the use of some
limited resources at the expense of future generations is possible because there is no market where future
generations could express their willingness to pay for those resources, etc.
98
In their analysis of the varieties of capitalism, Hall and Soskice 2001 noted the structural differences
between Western capitalist economies. Different degrees of regulation and differences in contract law
could explain different corporate strategies. The theoretical literature on economic search suggests that
high quality strategies go together with a preference for high levels of transparency and information about
the firm’s efforts to ensure this quality; more and more, quality encompasses aspects of impact on
communities (decent labour, quality of the environment, etc.) or the biosphere (carbon footprint, impact on
biodiversity, etc.).
99
Insurance products, including those tradable on exchanges, will become available over time, but we are
certainly very far from a satisfactory situation from the point of view of an average EU based medium size
company. See for example European Commission, SWD Closing the Climate Protection Gap, 2021.
100
Rasgupta review on the Economics of Biodiversity.
18
projected to increase substantially101
. This pressure is not reflected in market prices,
making it invisible to market participants. 102,103
Furthermore, as regards companies listed on stock exchanges and their value chain
partners, pressure exerted by shareholders also contributes to corporate decision-
makers’ short-termism. In this context, the demand by investors for more disclosure on
sustainability impact is certainly positive, but does not appear sufficient to correct the
incentives in place.
Addressing the problem of short-termism has been on the regulatory agenda since the
financial crisis.104
The 2018 Final report of the High-Level Expert Group on Sustainable
Finance argues that sustainability is axiomatically linked to the long term: investment in
infrastructure, renewable energy, climate change mitigation, etc. require a long-term
horizon, often over several years if not decades.
There is evidence of short-termism in the behaviour of EU listed companies. Between
1992 and 2018 the ratio of total shareholder pay-outs – i.e. dividend payments and share
buybacks – to corporate net income increased from 20% to 60% in listed European
companies with a non-negative income. Simultaneously, business investment – in terms
of the ratio of capital expenditure (CAPEX) and research and development (R&D)
spending to net income – has declined by 45% and 38% respectively105
. While the study
has been criticised by a number of contributors, in particular as regards methodology106
,
it can be stated that it builds on a broad set of data sources, including information
obtained from economic databases, from literature and regulatory review, complemented
by the results of the contractor’s own survey. Also, other studies confirm the trend
101
https://www.economist.com/finance-and-economics/2021/02/06/how-should-economists-think-about-
biodiversity.
102
See detailed analysis in the third progress report of the Institute of European Environmental Policy:
Mapping objectives in the field of environmental taxation and budgetary reform: internalisation of
environmental external costs, December 2020. See also Rasgupta review on the Economics of Biodiversity
103
As regards carbon for example, the Economist estimates that the economic loss to humanity from
emissions ranges from around $30 to $400 a tonne.
104
The Kay Review, 2012, demonstrated how short-termism, which largely stems from short-term
incentives in the institutional investment chain, results in short-term pressure on investee companies and
how companies respond to such pressures. The report argued that short-termism in business is a tendency
to under-invest, whether in physical assets or in intangibles such as product development, capacity for
innovation, employee skills, reputation.
105
See Supporting study on directors’ duties. The economic analysis in this study is based on the available
financial information from 1992 to 2018 of 4,719 listed companies in 16 countries (15 MS plus the UK).
The sample of positive net income companies included 4,154 companies. Net income is calculated by
subtracting some of the costs associated with certain future-oriented activities, but adding those costs does
not significantly change the overall trend. In the period under analysis the ratio of total pay-outs to net
income increased also on the entire sample by 17 percentage points. Also, the share of companies that
allocate more than 75% of their net income to pay-outs increased substantially: from 4% of the revenues in
1992 to 37% in 2018. Over the last two decades the indicators that proxy short-termism seem to have
stabilised around high levels of payments to shareholders and low investment intensity.
106
See further in Annex 2, Feedback to the IIA and position papers under the open public consultation.
19
identified107
. Recent research as regards corporate revenue from taxonomy aligned green
activities confirm the low level of sustainable corporate investments too, showing that the
share of “sustainability investment” within corporate investment is also low108
.
While increased investment into intangibles may explain the relative decline in CAPEX
investment over the last years, research estimates that this factor contributes only to a
small extent to reduced investments.109
Some contributors110
argue that the funds
distributed to shareholders can be re-deployed into venture capital or other listed
companies with cutting-edge research and sustainable investment projects. However,
venture capital investment in green start-ups for example accounts for about a tenth of all
venture capital investment and firms which sell goods or services that cut emissions
made up just five of the top 100 firms globally in 2020’s public-listings. Also, resources
distributed to shareholders are more often reinvested on secondary markets which results
in less resources available for investment into real productive assets at the company
level.
As regards shareholder short-term pressure on listed companies to deliver quarterly
results, shortening of shareholding periods in general (on average 8 months on stock
exchanges) and that of long-term investment strategies’ average holding period for shares
have been used as indicators111
. Short-termism was attributed to the fact that the biggest
part of assets of pension funds and insurance companies (institutional investors with
long-term liabilities and hence with interests in the long-term performance of companies)
are managed by asset managers the performance of which is ranked and evaluated on a
quarterly basis or in shorter time-frame, creating incentives in the asset management
market for short-term performance. The average holding period of shares in active,
long-term investment strategies (excluding hedge funds and other short-term strategies)
is 1.7 years showing that the average “long-term” investment horizon is less than 2
years. Less than 10% of asset managers had a three year investment horizon.112,113
107
See, for example, “Share Repurchases in Europe: A Value Extraction Analysis”, Sakinç (2017). The
study finds significant increase in dividend payments, increase in share-buybacks, significant decrease in
CAPEX investment and largely stagnating R&D expenses during 2000-2015 in largest 297 European
companies. A study from the US finds similar evidence for short-termism contributing to low investment
levels: G. Gutiérrez, T. Philippon, “Investment-less Growth: an Empirical Investigation”, 2016.
108
The research looks at 75 companies listed on three main European indices: EURO STOXX 50, DAX
and CAC 40 operating in taxonomy relevant sectors. It shows that 77% of analysed companies have an
alignment level equal to or lower than 1%, while 13% of analysed companies have an alignment level
equal to or above 5%. https://www.sustainablefinancesurvey.de/survey
109
G. Gutiérrez, T. Philippon, “Investment-less Growth: an Empirical Investigation”, as referred to above.
110
See for example the contribution of Styrelse Akademien Sverige or the Danish Committee on Corporate
Governance to the inception impact assessment.
111
Short-term buying and selling of shares may indicate that the shareholder focuses on quarterly (or more
frequent) gains as opposed to benefiting from long-term performance improvements.
112
Mercer, IRRC Institute 2010, Do managers do what they say?
113
Evidence shows that so called “insider ownership” (i.e. large stake owned by families) of large listed
financial firms did not lead to lower risk taking and did not reduce short-term focus in the run up to the
20
Also, long-term performance metrics, including environmental and social factors are
still insufficiently integrated into investment strategies114
despite EU action as a
follow-up to the sustainable finance strategy.115
Too strong focus on short-term financial performance reduces companies’ ability to
integrate long-term sustainability considerations adequately into business strategies and
prompt companies to sacrifice investments necessary for the longer-term viability of the
company. This has two aspects: first, companies may not properly identify and
address long-term sustainability factors, such as environmental, including climate
change, social, health and human rights (including labour rights, child labour, etc.)
risks and impacts in their operations and value chains. Secondly, companies may fail to
integrate potential new opportunities either for investment or for building
resilience.116
2.2.1.2.Directors’ remuneration incentivises improving short-term (share price)
performance (for listed companies)
Studies show that directors’ compensation places too high value on short-term value
creation, disregarding long-term value for the company, including for its stakeholders117
.
Remuneration focuses too much on financial performance118
. Among the 8 targets an
average CEO in 2017 had to meet, only 1 was a target for sustainability performance, the
others for financial performance. Remuneration schemes are also too short-term
oriented.119
On average, half of executive compensation in Europe is stock-based120
, which reinforces
pressures to manage corporate resources in a way aimed to increase share price in the
financial crisis: Corporate Governance in the 2007-2008 Financial Crisis: Evidence from Financial
Institutions Worldwide (fdic.gov).
114
For example, investment strategies integrating ESG matters (i.e. by far the most popular responsible
investment strategy) amounted to a mere EUR 4 trillion of assets under management, while impact
investing, i.e. where investors seek positive social or environmental impact, reached EUR 108 billion in
assets in 2018, Eurosif SRI study, 2018. In comparison assets managed by European asset managers
amounted to EUR 23.8 trillion in 2017.
115
A recent research covering the biggest 75 asset managers shows that only one-fifth of them have a
dedicated policy on climate change and only two have committed to align all portfolios under management
with the goals of the Paris Agreement Point-of-no-Returns.pdf (shareaction.org). A recent study shows that
despite their high quality green innovation, energy intensive companies are disadvantaged by the current
ESG investment strategies, L. Cohen, U. G. Gurun, Q. L. Nguyen “The ESG-Innovation Disconnect:
Evidence from Green Patenting”.
116
This ‘tragedy of horizons’ is arguably clearest in the context of climate change, the impacts of which are
felt beyond individual companies, but applies to all sustainability factors. See HLEG 2018 report.
117
Reward Value Green Paper, 2020.
118
Reward Value Green paper, 2020. The 5 most common financial targets are the share price, Earnings
per Share (EPS), sales, Return on Assets/Invested Capital, and Free Cash Flow (FCF).
119
Most absolute performance targets (typically: accounting and other targets) only have a 1-year horizon.
Relative performance targets (virtually exclusively: share price/total shareholder return) have a 3-year
horizon on average, overlapping annual vesting cycles imply a horizon that is often shorter.
120
Kotnik et al., “Executive compensation in Europe: Realized gains from stock-based pay”, 2018.
21
short-term121
. Current compensation designs can drive directors to (short-term) inflate
corporate performance to ‘game’ their pay-out. For example a 2017 study122
finds that
when CEOs’ equity is about to vest, they cut R&D spending and CAPEX investment to
maximise short-term profit and stock price. Short-term focused pay is a barrier for long-
term value creation123
.
2.2.1.3.Directors’ duties are misinterpreted as requiring short-term financial
value maximisation
The link between short-termism and poor sustainability outcomes by the companies has
been also highlighted in company law research where shareholder primacy in corporate
governance has been pointed out as the most powerful barrier against more
environmentally sustainable companies.124
It is argued that while company law in general
gives directors ample scope to take account of sustainability, company law has also
facilitated the development of an almost exclusive focus on short-term financial value
maximisation to the point of constituting the main barrier to more sustainable companies.
2.2.1.4.Stakeholders’ voice is not sufficiently channelled into corporate
decisions
A greater involvement of all stakeholders can help companies (listed and non-listed) to
counterbalance short-term pressure from markets and short-term investors and give
“voice” to subjects with a strong interest in the long-term sustainability of the company.
However, stakeholder involvement in corporate decision-making is rather limited,
especially when it takes place through voluntary company initiatives125
. Mandatory
requirements relate mainly to employees (minimum information and consultation of
employees at EU level and legal requirements for board level employee representation in
national laws126
), whereas consultation or engagement with other stakeholders is more
limited. The French due diligence law recommends setting the company’s due diligence
strategy in agreement with its stakeholders, but implementation of this recommendation
appears to be weak127
. Stakeholder engagement on human rights-related matters is
121
See also the Supporting study on directors’ duties which finds that: “a substantial strand of literature
argues that share-based remuneration of executives reinforces, rather than works against, the capital market
pressure for maximisation of returns to shareholders in the short term”.
122
Edmans A., Fang V. A., and Levellen K.A., “Equity vesting and investment”, March 2017.
123
A study examining the effect of incentives in the Stoxx Europe 600 index of big European companies
between 2014 and 2019 found a positive impact of high pay on performance over the short term (next 12
months). Yet no such relationship showed up over a three-year period, implying that the initial gains soon
dissipated. Baeten, X., Van Hove, M., What to reward executives for?, 2021.
124
The Sustainable Companies Project (2010–2014), led by Prof. Beate Sjåfjell of the University of Oslo.
125
See, for example, EY study on directors’ duties and sustainable corporate governance.
126
Directive 2002/14/EC and Directive 2009/38/EC, see Annex 8 for national laws.
127
CGE-RAPPORT-devoir-de-vigilance, January 2020, p. 37.
22
generally low across Europe128
. The public consultation shows diverging views for action
in this area. 129
2.2.1.5. Companies lack sufficient knowledge of their global value chains,
including risks and dependencies related to these. They do not have the
right tools to address sustainability risks and to identify impacts
The more supply chains are global, long or complex, the more limited is the knowledge
of companies’ of their full supply chains130
, as its traceability remains challenging. Key
issues are lack of transparency due to inconsistent or missing data, fraudulent data, lack
of interoperability of data systems between actors, lack of appropriate tools, financing
and human resources in case of smaller companies131,132
.
This can represent a risk to companies’ operation (for example if there are unknown
dependencies on a particular supplier or country) or ability to adapt to sudden disruption
in the supply chain.133
Moreover, appropriate traceability helps industries in optimizing
supply chain, knowing market status, improving product’s quality etc.134
In addition, research reveals that human rights violations at the supplier level are often
rooted in the buyers’ own purchasing practices, particularly by timing demands, pricing
pressures and last‐minute order modifications, turning a blind eye to human rights issues.
Therefore buyers’ purchasing practices are central to protecting workers from human
rights abuses or protecting the environment.135
This is even more relevant for companies
with thousands of suppliers in their supply chains.
128
The Alliance for Corporate Transparency Research Report 2019.
129
66 % of respondents believe directors should establish mechanisms for engaging with stakeholders in
defining corporate strategy and due diligence processes. Most support (93.1%) is derived from NGOs
while individual companies and business associations expressed hesitation with 68.0% disagreeing.
130
Most recently exemplified in the lack of resilience of companies and disruptions of supply chains during
the COVID-19 crisis. OECD (2020) COVID-19 and responsible business conduct; OECD (2021) Global
value chains: Efficiency and risks in the context of COVID-19
131
Is there a role for blockchain in responsible supply chains?, OECD paper (2019)
132
The draft interim report of an ongoing study on Uptake of Corporate Social Responsibility by European
SMEs and start-ups (June 2021) shows that SMEs face constraints to apply the principles of supply chain
diligence in practice because SMEs lack the capacities (resources and time) to monitor their supply chains
by themselves and investigate beyond their immediate suppliers. Also, the 2016 Timber Regulation
evaluation found that costs of developing and exercising a due diligence system vary significantly,
including depending on the number and geographic location of timber suppliers, complexity of the supply
chains and the size of the company. SMEs seem to be in a disadvantaged position due to their low
economies of scale, as the costs of the due diligence needs to be covered by a lower turnover. The
evaluation shows that many small and micro firms have not only not implemented the Regulation but are
still unaware of its implications.
133
Undertakings that have taken proactive steps to address the risks related to the COVID-19 crisis in a
way that mitigates adverse impacts on workers and value chains improve their viability in the short term
and their prospects for recovery in the medium to long term.
134
A. Regattieri, M. Gamberi, R. Manzini Traceability of Food Products: General Framework and
Experimental Evidence, 2007.
135
D. C. Snyder, S. A. Maslow, American Bar Association, Balancing Buyer and Supplier Responsibilities
in International Supply Chains
23
Digitalisation and new technology tools hold great potential to help companies
understand their value chain.136
However, despite their availability, many companies still
lack an overview of their entire value chain.137
Progress on mapping supply chains and
traceability is being made.138
The integration of sustainability risks within companies’ risk management is at an
early stage in all sectors139
, and there is a lower level of maturity in the identification and
management of sustainability risks to the company itself as compared to human rights
and environmental impacts. While there are broadly recognised international policy
frameworks and voluntary standards on the measurement of adverse sustainability
impacts, there are currently no mandatory or commonly recognised frameworks,
standards or guidelines for sustainability risks to the company and their
management140
. To date, markets have not been pro-actively dealing with sustainability-
related risks that can be disruptive to companies’ activities and that are likely to affect in
similar ways many companies operating in the same sector.
Standards on identification and mitigation of sustainability impacts are often not in line
with scientific goals, although private standards tend to converge towards the climate
neutrality and deforestation neutrality objectives.141
Furthermore, even where market tools facilitate appropriate impact mitigation, practice
lags behind using them. This is in particular the case with setting corporate level targets
aligned with the Paris Agreement targets for which the Science Based Targets (SBT)
initiative has developed a target setting tool for companies in 47 sectors142
. Most
participating companies consider their SBT a win-win: 63% of companies say their SBTs
drive innovation and 55% claim to have gained competitive advantage from SBTs. Other
initiatives are developed for frameworks and tools to set Corporate Context-Based Water
Targets143
however, are so far not used by the majority of companies144
.
136
World Business Council for Sustainable Development (2019) Is technology a game-changer for human
rights in corporate value chains?; BCG (2018) Pairing Blockchain with IoT to Cut Supply Chain Costs;
McKinsey (2016) Big data and the supply chain: The big-supply-chain analytics landscape; Business
Innovation Observatory (2015) Traceability across the Value Chain: Advanced tracking systems.
137
Arviem (2018) White papers “Chemical Supply Chain Visibility” and “Food Supply Chain
Traceability”.
138
Supporting study on due diligence (2020), p.71. e.g. Nestlé’s practices in its supply chain are considered
as a “notable example” on traceability while the new transparency policy of H&M is an example of how a
company with a complex supply chain can achieve traceability.
139
Supporting study on directors duties and sustainable corporate governance (2020).
140
Ibid.
141
For an overview of private responsible business standards, see ITC Voluntary standards (intracen.org)
142
See data from EcoVadis’ rating responses on use of SBTs as quoted above (footnote 89).
143
Several financial institutions (including BNP Paribas and AXA) have joined in an initiative to develop a
biodiversity assessment methodology and tool to assess the impact of investors’ portfolios on biodiversity
environmental advisory firm and a data provider. The aim is “to enable investors to integrate impacts to
nature and biodiversity into their risk assessments”. See also WWF work on context-based and science-
based water targets, World Resources Institute work on setting Site Water Targets Informed By Catchment
Context, etc., EU Taxonomy regulation, etc.
24
The public consultation shows the need for the development of adequate risk and impact
management tools and also guidance related to due diligence.145
2.2.2. Regulatory Inefficiencies
2.2.2.1.Directors’ duty to act in the interest of the company is often unclear,
company law and corporate governance frameworks emphasise
accountability towards shareholders
Directors’ duties and liabilities are regulated in all EU Member States for all limited
liability companies, all accepting the principle that directors’ duties are owed to the
company. The core duty of directors to act in the interest of the company as a whole is
regulated in all Member States146
.
But not all national laws regulate what the “interest of the company” means and what
specific interests directors need to take into account. In some Member States the law has
lately required stakeholder interests to be taken explicitly into account, and even their
priority over shareholder ones, but in most Member States national law is largely
unclear about how directors should take into account the long-term consequences of
decisions, the interests of employees and other stakeholders affected by the company’
activities or the interests of the global and local environment147
.
As a result, interpretations, mostly by courts or academia, diverge in terms of interests
to be protected (of shareholders, of stakeholders or of society). Within this general lack
of clarity, the focus of directors on the short-term financial performance has become a
widely used practice148
over the last decades.
While the management’s main role is to manage risks and the board oversees risk
management, sets strategy and supervises its implementation, there are no obligations to
manage risks linked to the environment, social factors, human rights and the company’s
adverse external impacts, or to integrate sustainability aspects into the corporate strategy.
In some Member States (like Germany), there is a legal obligation for the board to set up
and supervise a firm-wide compliance system for damage prevention and risk control149
.
144
The Alliance for Corporate Transparency Research Report 2019 shows that 36.4% of 1000 studied EU
companies report on their climate targets, 13.9% report on the alignment of such target with the Paris
Agreement/Science Based Targets. In the energy sector, these numbers stand at 36% and 24%.
145
As regards developing adequate risk and impact management tools, respondents noted binding
requirements would bring benefits “in term of risk management, resilience, environmental/social
performances and reliability”, and as regards developing guidance, respondents deemed it an effective tool
specifically to ease the potential burden on SMEs.
146
LSE study on directors’ duties and liability, 2013.
147
See Annex 8 for more information on national frameworks and interpretations by courts.
148
See Supporting study on director’s duties and Horizon 2020 SMART research reports about the “social
norm” of shareholder value maximisation
149
See in particular § 91 paragraph 2 Aktiengesetz (Stock Corporation Act). Board members have been
sued for not having established a group-wide risk management system for a specific non-financial matter
Judgment by the Munich Regional Court of 10 December 2013, Siemens vs Neubürger, 5HK O 1387/10.
25
The existing corporate governance codes’150
“comply or explain” character and
recently adopted EU corporate governance rules (for example strengthened shareholder
rights, including a shareholder “say on pay” and provisions on independent directors151
)
strengthen directors' accountability towards shareholders, but not the coverage of
interests of other stakeholders and the environment.
2.2.2.2. Company law lags behind the emergence of globalized companies,
groups and value chains
Over the past three decades, production has become strongly internationalised for EU
companies of all sizes152
. Global value chains account for almost 50% of global trade
today153
. Upstream production (mining, manufacturing, assembling) processes are often
located in countries where labour and environmental standards are lower than in the
countries where products are marketed154
. The companies in the upstream parts of the
value chain are rarely known to the consumer, therefore reputational risks have less
chance to materialize, creating a moral hazard problem within the value chain. This is
particularly clear in the case of supply of raw materials which in addition tends to be
concentrated in countries with low levels of governance, which may result in harmful
social and environmental impacts155
. In certain cases, EU companies are also dependent
on sourcing from those countries as no substitutes are available. Given the strong global
competition for those materials, they may lack leverage in those countries.
National legal frameworks differ as to whether the board of a parent company has a duty
to implement supervision or even governance over a subsidiary, a situation that is not
conducive to creating a level playing field for companies in the internal market. The duty
to oversee the subsidiaries is developing in a few jurisdictions156
and may also be
induced by EU legislation157
. Parent companies’ duty to adopt and implement a group-
wide sustainability policy was introduced first by the French duty of vigilance act. That
law is innovative also for recognizing that control can be exercised through contracts.
Global value chains are a web of contracts which have the potential to exert control over
suppliers and subcontractors, even beyond direct subcontractors as through the
purchasing policy of the buyer company it can exercise control and influence on its
150
For more details on the functioning of Corporate governance Codes as voluntary “comply or explain”
instruments, see Annex 6.
151
Please refer to Annex 6 for an overview of existing EU CG instruments.
152
Eurostat, International trade in goods by enterprise size. In 2018, the share of EU SMEs in the number
of extra-EU importers was 95%, the share of EU SMEs in the value of imports from outside the EU was
40%.
153
World Bank, Trading for Development in the Age of Global Value Chains, 2020.
154
According to Eurostat, close to 50% of EU imports of textiles originate from China and Bangladesh,
where cases of forced labour and violations of health and safety standards and labour rights occurred.
155
CEAP 2020 Staff working document ‘Leading the way to a global circular economy: state of play and
outlook’, p.9.
156
Germany, Netherlands.
157
Special regulation applicable to financial institutions may require that the parent company takes
responsibility for the governance of the whole group, especially from a risk management perspective, see,
for instance, the Capital Requirement Directive, Articles 74 et seq. and Article 84 et seq.
26
suppliers’ activities158
. However, in particular beyond tier 1 suppliers, companies might
not have sufficient leverage to do so. Furthermore, it might be more difficult to exert
leverage in some countries where global competition for some very essential raw
materials is strong. While some company law regimes recognize at least some duties of
the parent company concerning subsidiaries based on control through group policies and
corporate ownership, EU and national company law lags behind recognizing de facto
control over value chain partners’ adverse impacts.
2.2.2.3.Voluntary due diligence standards are not effective to mainstream
adequate impact management, do not provide for legal certainty and
many of them are not comprehensive
As explained in section 2.1.3, over the past decade, non-mandatory policy frameworks
such as the UNGPs159
, the OECD Guidelines for Multinational Enterprises and
accompanying due diligence guidance, private standards and initiatives have been
developed160
with different levels of ambition and coverage of human rights and
environmental matters. All these guidance appear to lag behind the EU Green Deal’s
ambition in terms of climate and biodiversity neutrality and zero pollution. Given the
“guidance” character of these documents, they recommend different ways in dealing with
issues and sometimes include inconsistencies (for example when it comes to terminating
business relationships). Given also their voluntary character, they do not provide for
sufficient legal certainty for businesses, in particular in light of the Court cases where
companies’ responsibility is established. 82% of public consultation respondents, NGOs
95.9%, companies 68.4% and business associations 59.6 % saw the need for developing
an EU legal framework for due diligence, and achieving legal certainty was one of the
top 5 benefits expected. Industry sector initiatives and private standards are also evolving
and, albeit helpful in many sectors, they present the same weaknesses. They are often
incomplete, do not focus on all risks161
and may lack credibility and transparency.162, 163
158
This line of reasoning is followed also in the Shell judgement (see part 4.4.25 Milieudefensie v. Shell):
“It is not in dispute that through its purchase policy the Shell group exercises control and influence over its
suppliers’ emissions. […] This means that through the corporate policy of the Shell group,
R[oyal]D[utch]S[hell] is able to exercise control and influence over these emissions. […]”. The same
applies for the emissions of the product of the company: “Through the energy package offered by Shell
group, R[oyal]D[utch]S[hell] controls and influences the Scope 3 emissions of the end-users of the
products produced and sold by the Shell group. […]”.
159
They provided the first global standard for preventing and addressing the risk of adverse impacts on
human rights linked to business activity, and continue to provide the internationally accepted framework
for enhancing standards and practice regarding business and human rights. See also Glossary (above).
160
ITC: Mapping of voluntary sustainability schemes – the Standards Map project.
161
Some initiatives relate to one specific impact, e.g. GHG emissions (e.g. the Science-based targets
initiative), deforestation risks, some only relate to human rights issues (e.g. Action, Collaboration,
Transformation (ACT) Initiative focussing on labour rights in the garment and textile industry), others only
relate to the environment. See also the supporting study on due diligence, illustrating at p. 343 how
different voluntary initiatives in the minerals sector focus on different selected human rights issues.
162
Supporting study on due diligence, p. 243 et seq. with examples from the garment sector, regarding
deforestation risks, and in relation to climate change. See also p. 334 et seq., 342. See also UN Human
27
These instruments lack effectiveness to mainstream adequate due diligence practices,
as also evidenced by the results of the public consultation164
.
Such frameworks appeared to have incentivised only the frontrunners, as only 30% of
large companies say they carry out comprehensive due diligence of human rights and
environmental harm165
, and focus mostly on their first tier suppliers.
Due diligence law has been to a certain extent more effective to trigger change166
.
Evidence from some of the limited number of existing mandatory sustainability due
diligence national legal frameworks in the European region shows that they are
effective in triggering change in the value chains regarding sustainability matters.
For instance the French Vigilance Law’s effects had already become apparent a short
time after its entry into force167
, showing also how – irrespective of personal scope – its
impact trickles down the value chain and obligations are shifted on suppliers mostly
without recognition (for instance in prices): 80% of French SMEs and midcaps (which
are out the French law’s scope) are asked by their contractors on CSR issues, whether to
sign a charter or a code of conduct, to declare themselves in conformity with the main
social and environmental standards (health/safety, waste management, business ethics or
human rights), to sign clauses in their contracts or to undergo an extra-financial
evaluation168
. Also the due diligence requirements in the UK Bribery Act include the
duty to prevent, coupled with a due diligence defence is more effective than the
transparency regime of the Modern Slavery Act169
.
2.2.2.4. Emerging laws set diverging corporate due diligence and accountability
requirements
Emerging EU and national laws on corporate due diligence differ. This situation creates
fragmentation and emergence of barriers within the EU single market. Diverging rules
Rights Council, “Report of the Special Rapporteur on extreme poverty and human rights: Climate change
and poverty” (17 July 2019) at para 48.
163
For instance, a study by Germanwatch on mineral supply chains demonstrates that audits and
certification schemes alone, even independent and high-quality ones, are not sufficient to ensure that an
approach is credible and has any benefits for rights-holders: Sydow J., Reichwein A. (2018). Governance
of Mineral Supply Chains of Electronic Devices.
164
As evidenced in sections 2.1.3 and 2.2.1.5 adequate due diligence practices are not mainstreamed,
which is also supported by the findings of the public consultation whose respondents saw a clear need for a
due diligence framework and saw potential benefits in: (1) harmonisation to avoid fragmentation (82.1%),
(2) awareness of companies’ negative impacts (79.9%), (3) effective contribution to a more sustainable
development ( 76.5%), (4) levelling the playing field (75.5%) and (5) increased legal certainty (70.3%).
165
Supporting study on due diligence.
166
OECD (2016): Report on the Implementation of the Recommendation on Due Diligence Guidance for
Responsible Supply Chains of Minerals from Conflict-Affected and High-Risk Areas.
167
Evaluation de la mise en œuvre de la loi relative au devoir de vigilance, January 2020.
168
Enquête “RSE : La parole aux fournisseurs !”, January 2020 , Devoir de vigilance : les PME en
première ligne, sans être assez accompagnées par les donneurs d'ordre shows supply chain companies, in
particular SMEs, complaining about price pressure and lack of recognition of their efforts in prices.
169
Lebrun G., Rühmkorf A. (2017). Steering CSR Through Home State Regulation: A Comparison of the
Impact of the UK Bribery Act and Modern Slavery Act on Global Supply Chain Governance.
28
are thus un-levelling the playing field for companies based in different Member States.
Moreover, they lead to additional administrative burden and costs for firms operating
across borders170
.
EU due diligence rules exist only for a limited number of products171
in the Responsible
(conflict) Minerals Regulation, the EU Timber Regulation, and in the Battery Regulation
Proposal. Besides, they differ as regards the obligations for companies in their scope and
relate to specific sustainability concerns. For instance, the Responsible Minerals
Regulation covers armed conflict and related serious human rights abuses, the
Deforestation initiative will cover deforestation risks.
National rules are in the making and although all seek to align with existing international
standards, they are different in terms of scope, risks covered, level of detail, enforcement
and liability. The French due diligence law applies to both human rights and
environmental harm. The German law focuses on human rights and some specific
environmental risks only172
. The Dutch law applies to child labour only. In terms of
concrete obligations, the French law includes only essential due diligence elements while
the German law is detailed. Personal scope, enforcement and liability regimes differ. See
further information on diverging national laws and EU due diligence rules in Annex 8.
As referred to above, the public consultation shows that stakeholders consider
harmonisation, to avoid fragmentation and levelling the playing field being among of the
main benefits of an EU due diligence duty.
2.2.2.5.Victims face legal barriers to hold companies to account and get
remedies
Victims of human rights violations or environmental harm may face barriers to claim
access to remedy, which contributes to an accountability vacuum. This also contributes to
companies insufficiently addressing adverse impacts. Cross-border incidents, in
particular, when the harm occurred outside of the EU in the company’s value chain
present the biggest challenges for victims of harm caused by corporate action. These
challenges may include uncertainty as to whether the involved non-EU companies or
suppliers can be held liable, which is the competent jurisdiction, lack of information,
increased costs, language and legal knowledge barriers among others173
.
The lack of a clear obligation to conduct value chain due diligence is an obstacle itself as
it makes it uncertain whether the EU company can be held liable or whether claims can
170
The respondents to the open public consultation believe that the UK Modern Slavery Act is an example
of no binding requirements and liability bringing no effect.
171
Four minerals; timber and timber products; specific category of batteries. Six agricultural products in
the planned Deforestation initiative.
172
For instance, when they lead to human rights violations (e.g. poisoned water or violations of some
specific international agreements).
173
See, for example, chapter 3 of the FRA 2020 Report “Business and Human Rights – Access to
Remedy”.
29
only be directed towards the subsidiary or supplier in the value chain174
. Even if the EU
company could be sued in the EU, European private international law rules differ as to
the applicable law to non-contractual obligations when the harm occurred in a third
country depending on the nature of this harm (e.g. environmental damage is subject to a
special rule allowing to choose the law of the country in which the event giving rise to
the damage occurred, rather than relying on a general rule of applicable law in tort cases,
i.e., law of country of the place of damage, such a choice does not apply to human rights’
harms where a general rule applies)175
. Other barriers include burden of proof, access to
evidence, legal standing of the victims or their representatives, or limitation periods.176
Public consultation respondents confirmed such difficulties exist and listed a number of
examples of barriers to justice (legal, procedural and practical) in holding European
companies liable for the harm caused by their subsidiaries or value chain partners located
in a third country.177
2.3. How will the problem evolve?
Identification of risks is expected to improve and general disclosure of sustainability
information (from CSRD and taxonomy) will improve the situation at least in terms of
awareness. Sustainability risk management is expected to improve to some extent as a
result of growing financial impacts of such risks on companies and shifting consumer
patterns. Standardised sustainability risk reporting and improving investor awareness
partly due to regulation178
is expected to have some positive impact on large companies
and on listed companies in the EU single market. As regards human rights and
environmental impact mitigation, EU law is developing, in particular as regards targeted
climate change action, pollution and circular economy measures, which will result in
reductions of adverse climate and environmental impacts primarily within the EU. The
COVID crisis resulted in better awareness of the global exposure and dependencies in the
EU supply chains.
At the same time, these developments are not likely to generate a change that is
sufficiently quick, even, systemic and wide-spread across the economy as regards all
risks and impacts. Pressure on natural capital is expected to significantly increase in the
near future despite international commitments and this will exacerbate risks. EU law will
174
Existing non-mandatory policy frameworks, such as for example the UNGPs stress the responsibility of
the company to identify and mitigate harm in its value chain. The liability of the EU company is meant to
encompass only its own failure to conduct due diligence, identify, prevent and mitigate harm. Emerging
jurisprudence (for example the Shell judgement) suggest a due diligence duty to mitigate adverse climate
change impacts through the company’s group and value chain.
175
See Articles 4 and 7 of Regulation (EC) No 864/2007.
176
What if, European Coalition for Corporate Justice.
177
E.g. Boliden, KiK case and Shell case. Respondents suggest that EU laws and rules on jurisdiction
should allow for the liability of parent and lead companies. In seeking the right to claim compensation,
victims should be able to rely on EU law, which should provide for reasonable time limitations for bringing
legal actions.
178
See for example recent investor disclosure rules in Annex 6.
30
have impact primarily within the EU. Competitive pressures, investor short-termism as
well as resulting short-term decision horizons are unlikely to decrease in global markets
resulting in sub-optimal levels of corporate investments into longer term (innovative)
projects and cost reductions will continue through outsourcing activities in third
countries with mostly lower human rights and environmental standards. This will prevent
companies from benefiting from opportunities the sustainability transition offers,
including strengthening competitiveness. Furthermore, increasing fragmentation is
expected due to a number of member states planning to come up with rules in the
absence of EU legislation.
3. WHY SHOULD THE EU ACT?
3.1. Legal basis
The legal basis of the proposed initiative is Article 50 TFEU, which is the legal basis for
company law legislation aiming for measures regarding the protection of the interests
of companies’ members and others with a view to making such protection equivalent
throughout the Union, and Article 114 TFEU, which is a legal basis for harmonising
measures for the establishment and proper functioning of the internal market.
3.2. Subsidiarity: Necessity and value added of EU action
3.2.1. The problems identified are European and to some extent global and
Member States cannot tackle them effectively at national level
Member States’ legislation alone in the area of sustainable corporate governance is
unlikely to be sufficient and efficient as sustainability problems are of a European and
global dimension and have cross-border effects (climate change, pollution, transnational
supply and value chains). Unsustainable behaviour of companies in one Member State or
in third countries affects other Member States.
As regards specific trans-boundary problems, such as climate change, pollution, etc.,
individual action is hampered by the inaction of other Member States. The achievement
of international commitments such as the goals of the Paris Agreement on climate
change, the post 2020 Biodiversity agreement and the UN SDGs by individual Member
State action alone is unlikely, this is also the reason why commitments have been
undertaken by the EU. Although Member States are making more progress towards
achieving the SDGs by 2030 at different pace, meeting SDGs targets related to climate,
biodiversity, and circular economy remained challenging for all of them179
179
Europe Sustainable Development Report 2020: Meeting the Sustainable Development Goals in the face
of the COVID-19 pandemic. Such efforts will be further supported by the recently adopted package of
measures under “Fit for 55”.
31
3.2.2. Companies and their investors operate and invest across borders, value
chains are increasingly European and even global, short-termism is
systemic
Many companies are operating EU-wide or even globally; value chains expand to other
EU Member States and increasingly globally. Institutional investors which invest across
the borders own a large part (38%180
) of the total market capitalisation of large European
listed companies, therefore many companies have cross-border ownership and their
operations are influenced by regulations in some countries or lack of action in others. The
market failure of short-term focus181
affects the operations of European capital markets
and beyond. Therefore, it is unlikely that individual action by Member States without the
action of others would be sufficient to induce long-termism. If one Member State adopts
directors’ duties and due diligence rules, its companies owned by EU and international
investors and operating in open markets would still be subject to short-term pressures
creating a barrier to exploit their long-term potential. This is one of the reasons why
frontrunner companies arguably cannot go as far as they would want to in addressing
sustainability issues today182
and ask for a cross-border level playing field. EU rules have
better chances to mitigate such pressures on companies.
Market prices not reflecting externalities is also system-wide and cannot be successfully
tackled by individual national action.
3.2.3. Member States’ individual action leads to fragmentation and extra costs
Some Member States have recently introduced legislation on sustainable corporate
governance183
or due diligence184
, while others are in the process of legislating or
considering action185
. Existing Member State rules and those under way are or would
most likely lead to diverging requirements, which risk being ineffective and leading to an
uneven level playing field. New laws are considerably different186
especially on due
diligence despite the intention of all the Member States to build on existing international
standards (UNGPs, OECD Responsible Business Framework). There are considerable
indirect effects of diverging due diligence laws on the suppliers of companies that supply
to different companies falling under different laws, as the obligations are in practice
translated into contractual clauses. If duty of care on sustainable aspects and due
diligence requirements are significantly different among Member States, this creates
legal uncertainty, fragmentation of the Single market, additional costs and complexity for
companies and their investors operating across borders as well as other stakeholders.
180
This number comes from the Impact Assessment of the Shareholders Rights Directive II.
181
See above section 2.2.1.
182
Sustainability frontrunner Danone has recently been forced to cut costs by investors on grounds of lack
of short-term profitability, Can Anglo-Saxon activist investors whip Danone into shape? (The Economist)
183
France, Ireland, Portugal.
184
France, the Netherlands, Germany.
185
Finland, Luxembourg, Belgium on due diligence.
186
See in detail Annex 8.
32
Large companies across the board ask for greater harmonisation in the area of due
diligence to improve legal certainty and level playing field187
. However, there is less
support from business associations for harmonisation of some aspects of directors`
duties.188
Citizens and stakeholders demand EU action and perceive the current
regulatory framework as ineffective to ensure corporate accountability for negative
impacts on the environment and human rights189
. The European Parliament190
and the
Council191
are calling on the Commission to legislate in these fields.
3.2.4. The EU has already regulated in this area
Corporate governance is already regulated at EU level192
. New rules would build on this.
Further action at the EU level has a much bigger chance of leading to a true sustainability
transformation in the most cost efficient way than individual Member States action.
3.2.5. EU-level policy adds significant value for international action
Compared to individual action by Member States, EU intervention can ensure a strong
European voice in policy developments at the global level, in particular regarding due
diligence requirements in value chains193
.
In light of the above, EU regulation is both necessary and also adds value compared to
national legislation.
4. OBJECTIVES: WHAT IS TO BE ACHIEVED?
4.1. General objectives
The general objective of this initiative is to better exploit the potential of the single
market to contribute to the transition to a sustainable economy, to foster sustainable
value creation and improve the long-term performance and resilience of EU companies.
187
List of large businesses, associations & investors with public statements & endorsements in support of
mandatory due diligence regulation (business-humanrights.org). Open public consultation respondents
agreed that an EU legal framework for due diligence needs to be developed, with companies supporting the
need for action with 68.4% and business associations with 59.6 %.
188
In the open public consultation, while businesses expressed slight support, business associations
expressed disagreement when asked about if directors should be required by law to a) identify the
company’s stakeholders and their interests (64.6%), b) manage the risks for the company in relation to
stakeholders and their interests (65.6%) and c) identify opportunities arising from promoting stakeholders’
interests (69.9%).
189
See Annex 2 on stakeholders’ consultation.
190
For details see Annex 12 on European Parliament reports.
191
Council Conclusions on Human Rights and Decent Work in Global Supply Chains, 1 December 2020.
192
For details see the section on “Legal context“ above.
193
In 2014, the UN Human Rights Council decided to establish an open-ended intergovernmental working
group (OEIGWG) on transnational corporations and other business enterprises with respect to human
rights, whose mandate shall be to elaborate an international legally binding instrument (LBI) to regulate, in
international human rights law, the activities of transnational corporations and other business enterprises.
In 2021, the OEIGWG released a third revised draft LBI on business activities and human rights, including
due diligence measures and corporate liability for human rights abuses.
33
These objectives will be achieved through:
(1) increasing directors’ accountability for sustainable value creation and
incorporating (long-term) sustainability factors in decision-making of companies;
and
(2) increasing corporate responsibility for preventing and mitigating adverse human
rights and environmental impacts, including in companies’ value chains, in line
with the EU’s international commitments regarding human rights and the
environment.
4.2. Specific objectives
To reach the general objectives, the initiative pursues the following specific objectives:
a) clarify what is expected of directors in order to fulfil their duty to act in the
interest of the company as regards stakeholder interests and the long-term
interests of the company
b) foster the integration of sustainability risks (including from the value chain) and
impacts into corporate risk management processes, impact mitigation processes,
strategies, facilitate management of dependencies and ability to react to change;
c) increase accountability for identifying, preventing and mitigating adverse
impacts, including in value chains, avoid fragmentation of due diligence
requirements in the Single market and create legal certainty for stakeholders as
regards expected behaviour and liability;
d) improve access to remedy for those affected by adverse corporate human rights
and environmental impacts;
e) improve corporate governance practices to facilitate the integration of
sustainability into directors’ and company decision-making (e.g. in the area of
stakeholder involvement).
The intervention logic can be found in Annex 16.
5. WHAT ARE THE AVAILABLE POLICY OPTIONS?
5.1. What is the baseline from which options are assessed?
5.1.1. Corporate due diligence
Under the baseline, the regulatory environment would continue to evolve along national
corporate due diligence laws and EU initiatives focusing on certain issues, sectors or
products, as well as evolving international non-binding policy frameworks194
, and industry
voluntary initiatives. The principal characteristics of the baseline scenario are the following:
194
For example as regards the OECD responsible business framework, including OECD Guidelines for
Multinational Enterprises, the OECD Guidance on Responsible Business Conduct and OECD sectoral
34
Voluntary action by companies not leading to a level playing field for the
sustainability transition: The Corporate Sustainable Reporting Directive (CSRD)195
and
parallel EU measures on sustainability-related disclosures196
are expected to intensify
disclosure and reporting on sustainability issues by EU companies falling in their scope.
It can be expected that a number of companies in the scope of those measures may
become aware of their adverse impacts and adopt due diligence processes.197
However,
they will not require companies to prevent, address and mitigate adverse impacts
effectively and following the same procedural standards in the single market.198
As
shown in detail in Section 2.2.2.3 above, a voluntary approach to due diligence has not
been fully effective in mainstreaming due diligence practices and creating level playing
field. Reporting rules have proven in the past to incentivise frontrunner companies
only.199
Emerging jurisprudence interpreting companies’ standard of care under tortious
liability (i.e. the general duty not to harm others) as encompassing climate change harm
in their operations and the entire value chain200
may result in an incentive for companies
to build due diligence. In addition, the upcoming initiatives on empowering consumers201
and on green claims202
will reduce the amount of false claims, increase transparency and
support the market for sustainable products. It is expected that increased transparency
will help create consumer pressure that can incentivise companies to become more
sustainable. However, all these incentives appear insufficient to foster systematic
mitigation of adverse impacts and related risks in value chains across sectors. The EU
institutions and the Member States are legally required to enable the collective
achievement of the climate-neutrality objective.203
In the consultation activities, all
guidance, or the on-going UN negotiations on a legally binding instrument on business and human rights,
as referred to in footnote 193 above.
195
In this context, the European Financial Reporting Advisory Group (EFRAG) is responsible for
developing new EU sustainability-reporting standards.
196
This also includes Regulation 2019/2088. In addition, the delegated act in accordance with Article 8 of
the Taxonomy Regulation aims at further increasing transparency in the market. Companies in the scope of
the CSRD will have to disclose information to investors about the environmental performance of assets and
economic activities of financial and non-financial undertakings. See the draft Taxonomy Regulation
delegated act on article 8 (2021) .
197
E.g., the 2020 study on the NFRD found some evidence of limited changes in company policies that
could be partly attributed to the current requirements of the NFRD, but it is very difficult to disaggregate
the effect of the NFRD from other factors that may drive changes in company policies and behaviour.
198
A more detailed analysis of the new measures introduced by the CSRD can be found in Annex 7.
199
See Supporting study on due diligence, p. 99 to 105; 218 to 220; p. 245 to 250.
200
In Milieudefensie v. Shell, Shell group was required to bring its CO2 reduction target in line with the
1.5°C climate scenario in own operations, business relationships as well as impacts linked to its products.
201
The initiative on Empowering Consumers for the Green Transition will strengthen and improve
information at the point of sale on the durability and reparability of products and provide better consumer
protection against misleading practices in relation to sustainable purchases requirements that lengthen the
life of products.
202
The Green Claims Initiative on the substantiation of environmental claims strengthens the framework
for establishing in a reliable and comparable manner the environmental performance of products.
203
See Article 2 of the “European Climate Law” (Regulation (EU) 2021/1119).
35
categories of stakeholders agreed on the need for an EU legal framework on due
diligence.204
– A fragmented legal environment across the EU: In addition to France and
Germany, a number of other Member States are likely to introduce mandatory
horizontal due diligence requirements.205
Existing national laws differ with respect
to the companies, sectors, risks and supply or value chains covered, and with
respect to the enforcement regime. New national rules will add to this complexity.
This undermines legal certainty for companies and for those whose rights are being
protected in different ways across the EU. It results in an uneven playing field for
companies in the EU single market. This situation would also result in unnecessary
compliance costs. At the same time, some EU Member States are unlikely to
introduce any national due diligence requirements.
– A patchy legal framework at EU level that will not apply to companies in all
sectors: Existing and anticipated EU due diligence requirements would be
applicable to certain sectors, sustainability issues and commodities.206
Moreover,
a range of other EU measures have been launched or are in the preparation phase
under the European Green Deal, tackling specific sustainability impacts such as
climate, environmental, human rights or employment issues.207
To the extent that
they address companies, they may entail positive competitive dynamics if
sustainability considerations are increasingly integrated into corporate
management processes. However, such sectoral measures, mostly limited to the
EU, will not lead to a systemic change in corporate behaviour across sectors and
across sustainability risks, in particular in value chains outside the EU. The new
Generalised Scheme of Preferences (GSP) regime aims at making EU trade more
sustainable by promoting the respect for core human rights. It will support and
facilitate mandatory due diligence but cannot replace companies’ accountability
for sustainability impacts in their value chains. 208
204
For instance, in the context of the public consultation (carried out before adoption of the CSRD
proposal) 82% of respondents saw the need of developing an EU legal framework for due diligence and
92% indicated a preference for a horizontal due diligence regime.
205
See an overview of Member States’ laws and initiatives in Annex 8.
206
These include in particular the Responsible (Conflict) Minerals Regulation and its implementation , the
Timber Regulation and the potential new demand-side measures for deforestation and forest degradation
associated with EU consumption, and the Proposal for a new Batteries regulation (COM(2020)798), as
explained in Section 1.2.2 above and in Annex 7.
207
For example the Fit for 55 package (including, amongst others, the revision of the Emissions Trading
System, the Carbon Border Adjustment Mechanism and (CBAM), CO₂ emission performance standards for
new passenger cars and for new light commercial vehicles), the proposal for a Pay Transparency Directive.
Non-regulatory (voluntary) measures include the EU Eco-Management and Audit Scheme (EMAS), the
future EU legislative framework for sustainable food system and EU Code of Conduct for Responsible
Business and Marketing Practices which aims at improving the sustainability of the food value chain.
Furthermore, a proposal for a legislative framework for sustainable food systems is planned by 2023 as part
of the Farm to Fork Strategy.
208
See Annex 7 for more details on interlinked EU measures and added value of this initiative.
36
5.1.2. Directors’ duties
Under the baseline, action by companies will continue to be slow and uneven. As the
financial impact of (at least some) sustainability risks to the company will become more
pervasive with sustainability-related losses increasing over time, awareness in the market
is likely to increase. The CSRD is also expected to have a positive impact in terms of
improved transparency, awareness and, to a certain extent, the management of some
risks. Investors are likely to care more about sustainability risks and impacts209
, also as a
result of the numerous actions completed under the Sustainable Finance Action Plan on
investor disclosure and of the ECB’s incorporation of climate risks into supervisory
review210
. However, as proper sustainability risk mitigation requirements for investors
are only in the pipeline at this stage211
, such pressure may not be felt for still some time
and will remain indirect for a large group of companies (e.g. many non-listed
companies). In any case, at this stage, it is unlikely that such pressure will be strong
enough to mainstream stronger sustainability risk management and directors’
accountability for such risks, opportunities and impacts across industry. The
accountability of directors will remain limited and the market will unlikely deliver in line
with the needs of the broader economy, society and the goals enshrined in international
agreements. Overall, progress is expected to be slow.
In addition, problems related to the EU legal framework will persist. The table
shows some examples of how existing requirements at national level are incomplete and
diverging; more detailed information on Member States laws and initiatives in Annex 8.
Extent to which the notion of company interest integrates the promotion of long-term
value creation considering the interest of different stakeholders
Examples of Member States
Expressly regulated by law  France: Under a recent law, directors have to take
into consideration the social and environmental
challenges of the company’s activity;
 Netherlands: shareholder interests do not take
priority over the interests of other stakeholders
 Ireland: directors have to take into account the
interests of employees;
 Portugal: The interests of the company include
those of other relevant parties such as employees,
209
There is an increasingly wide range of research documenting the correlation between corporate attention
to human rights and broader ESG issues and corporate financial performance. See, for example, Money,
Millennials, and Human Rights and Cracking the ESG Code.
210
Disclosure and risk management requirements on some financial intermediaries, Sustainable finance
package, European Commission. Please see the ECB’s guide on climate-related and environmental risks.
Expectation 7.5 provides that institutions are expected to conduct a proper climate-related and
environmental due diligence, both at the inception of a client relationship and on an ongoing basis.
211
The renewed sustainable finance strategy aims at mainstreaming sustainability into risk management,
Renewed sustainable finance strategy and implementation of the action plan on financing sustainable
growth, European Commission.
37
clients and creditors in ensuring the sustainability
of the company.
Corporate Governance
Codes212 (comply or explain)
Belgium, Netherlands, Germany, Italy, Spain
Case law and legal literature Poland, Spain
In the baseline scenario, there would be continued uncertainty and fragmentation as
Member States’ approaches differ with regard to directors’ duty to act in the best interest
of the company and with due care.
5.1.3. Directors’ remuneration
In the baseline scenario, the rules on directors’ remuneration of listed companies adopted
in 2017 would apply:
Articles 9a and 9b of
the Shareholder
Rights Directive
(SRD)
(Directive
2007/36/EU, as
amended by Directive
(EU) 2017/828)
Transposition was due
by 10 June 2019
Companies have to
establish a
remuneration policy
for directors and draw
up a remuneration
report
The remuneration policy shall inter alia
- contribute to the company’s business strategy and long-term
interests and sustainability and shall explain how it does so;
- on variable remuneration indicate the financial and non-
financial performance criteria, including, where appropriate,
criteria relating to corporate social responsibility, and explain
how they contribute to the company’s long-term interests and
sustainability;
- on share-based remuneration: specify vesting periods and
where applicable retention of shares after vesting and explain
how the share based remuneration contributes to the
company’s long-term interests and sustainability.
The remuneration report shall contain, inter alia, where
applicable:
- an explanation on how the total remuneration complies with
the adopted remuneration policy, including how it contributes
to the long-term performance of the company,
- information on how the performance criteria were applied;
the number of shares and share options granted or offered, etc.
The current regulatory regime is largely based on disclosure. The Directive establishes
that remuneration policy shall contribute to the company’s long-term interests and
sustainability, but does not regulate how. The company can decide whether variable
performance criteria relating to corporate social responsibility will be used, and, if it uses
them, is required to report on them. Shareholders have a “say on pay”, therefore the
company’s performance on the environment and human rights is partly dependent on
their willingness to stand by it through an effective remuneration policy. While it would
be expected that the possible introduction of new due diligence obligations and directors’
212
For detailed information on these Corporate Governance Codes please refer to Annex 8.
38
duties would impact the manner in which companies implement the existing provisions
of the SRD, the provisions as they stand do not clarify that directors are incentivised or at
least not hindered by remuneration conditions to drive their companies towards a
sustainable transition.
Under the baseline, the future reporting standards under the CSRD proposal may cover
disclosures around how remuneration is linked with sustainability factors or with the
company’s sustainability targets which may indirectly foster a better integration of
sustainability into directors’ pay.
5.2. Description of the policy options
5.2.1. Corporate due diligence requirement throughout the company’s own
operations and in the value chain
In line with the UNGPs and the OECD Framework,213
the due diligence process consists
of the following 5 steps:214
1. Identification of actual or potential adverse human rights and environmental
impacts in own operations, in subsidiaries and in the value chain
Establish a system to properly address environmental and human rights adverse impacts
occurring in own operations, subsidiaries and throughout the value chain. Identify actual
or potential adverse impacts in operations and relationships where adverse impacts are
most likely to be present. Regularly evaluate operations and the value chain.
2. Prevention and mitigation of adverse impact in own operations, in subsidiaries
and in the value chain
Cease harmful activities, prevent and mitigate risks of possible adverse impacts.
Preventive measures include codes of conducts, contractual clauses with direct
contractors, including assurances that they will comply with requirements and adequately
address them in their value chain as well as regular controls and assurances of controls
from suppliers over their suppliers. Ceasing harmful impacts requires, as appropriate,
joint development of corrective actions with the supplier or joining forces with other
companies to exert influence on a value chain relationship where the company does not
have sufficient leverage. Ordering companies are required to provide adequate support in
fulfilling the requirements of SME partners in the value chain. Where the company
cannot prevent or cease adverse impacts or cannot build sufficient leverage, it is expected
to terminate the business relationship with the supplier as a last resort step in a
213
Including OECD Guidelines for Multinational Enterprises, the OECD Guidance on Responsible
Business Conduct and OECD sectoral guidance
214
See OECD-Due-Diligence-Guidance-for-Responsible-Business-Conduct including practical actions to
comply with the different due diligence steps. Please note that step 1 of the OECD Due Diligence Process
related to the embedding of responsible business conduct into policies and management systems would be
covered by the policy options on directors’ duties, see Section 5.2.2 below.
39
responsible way. Beyond direct contractors, the company is required to take every
reasonable steps to fulfil these requirements. Adverse impacts shall be addressed in a
way that takes into account the interest of the affected party (for example the victim of
the human rights abuse).
3. Tracking the effectiveness of measures
Track the implementation and effectiveness of the company’s due diligence activities.
4. Establishment of a complaint mechanism
Create a grievance mechanism, both as an early-warning mechanism for risk-awareness
and as a mediation system, allowing relevant stakeholders to voice reasonable concerns
regarding the existence of a potential or actual adverse impact.
5. Communicate how adverse impacts are addressed
Communicate externally relevant information on due diligence policies, processes,
activities conducted to identify and address actual or potential adverse impacts, including
the findings and outcomes of those activities. This element will be partially covered by
the CSRD.
5.2.1.2. Discarded options on due diligence
In addition to the baseline, we considered a wide variety of possible policy options. The
following policy options were discarded at an early stage: (i) non-regulatory measures,
(ii) a mandatory due diligence requirement without a civil liability regime, (iii) options
limiting the due diligence obligation to the company’s direct suppliers, (iv) options
limiting civil liability to harm caused at the level of the direct supplier.
Non-regulatory options such as a recommendation or guidelines building on existing
standards such as the UNGPs, the OECD Framework and industry schemes and
standards were excluded due to their limited effectiveness. Despite their beneficial
influence, the actual compliance with voluntary due diligence standards for human rights
and environmental impacts by businesses has been limited in practice. It is unlikely that
non-regulatory measures can mainstream adequate risk and impact management and
bring about the behavioural changes required for the transition to sustainability at a
sufficient scale and pace. Furthermore, an EU recommendation would not necessarily be
implemented by all Member States to the same extent. It would therefore not solve the
problem of fragmentation of the regulatory framework and could even increase
compliance costs and burdens for companies operating in several Member States.
A potential policy option covering a mandatory due diligence requirement without a
civil liability regime has been discarded due to lack of effective enforcement.
Experience shows that effective enforcement through administrative supervision alone
remains a major challenge. Furthermore, civil liability is important to ensure that victims
of adverse impacts can get access to remedy. International voluntary standards, such as
the UNGPs already expect companies to remedy such harm.
40
Options limiting the due diligence obligation to the company’s direct suppliers have
also been discarded due to lack of effectiveness and inconsistency with the international
voluntary framework215
. The most salient adverse impacts on human rights and on the
environment occur mainly outside the EU. They arise typically beyond direct suppliers,
further upstream in the value chain, for instance at the stage of raw material sourcing and
at initial manufacturing stages216
. Besides, recognised existing international voluntary
standards such as the UNGPs expect companies to undertake due diligence in their entire
value chain, and most of the companies have tools at their disposal to create visibility and
exert leverage beyond direct their suppliers e.g. through contracts, existing traceability or
chain of custody schemes, cooperation, assessments shared through a collaborative
initiative, identifying and cooperating with enterprises operating at control points of the
supply chain, etc.217
Moreover, an obligation covering only parts of a company’s value
chain could be easily circumvented by artificially establishing entities further in the value
chain to avoid compliance.
Lastly, a policy option covering whole value chain but limiting civil liability to harm
caused at the level of the direct supplier has been discarded. As explained above, most
adverse human rights and environmental impacts take place beyond the level of the direct
supplier. Such a policy option would not ensure an effective enforcement regime where it
is most needed. Legal certainty concerns can be addressed by adopting a sufficiently
clear liability regime as regards what can reasonably be expected from companies, in
particular with respect to indirect business partners in their value chains.
For a detailed analysis of these policy options and an explanation of why they were
discarded at an early stage, see Annex 13.
5.2.1.3. Options comprising a mandatory due diligence requirement for
companies
Screening of possible policy options
After filtering out the above-mentioned non-viable policy options, a variety of potential
options were screened focusing on three key elements: the companies to which the
obligations apply (personal scope), the content or extent of the obligations those
companies have to comply with (material scope), and how to ensure that companies
215
See OECD-Due-Diligence-Guidance-for-Responsible-Business-Conduct, see also the OECD’s Sectoral
Guidance, e.g. the OECD Due Diligence Guidance for Responsible Supply Chains in the Garment &
Footwear Sector; United Nations Guiding Principles on Business and Human Rights; see e.g.
commentaries to Principles 13, 17. See also the European Parliament resolution of 10 March 2021
(2020/2129(INL))
216
See e.g. Ending child labour, forced labour and human trafficking in global supply chains, ILO Report,
2019; OECD Due Diligence Guidance for Responsible Supply Chains of Minerals from Conflict-Affected
and High-Risk Areas.
217
See OECD-Due-Diligence-Guidance-for-Responsible-Business-Conduct.pdf, p. 68 et seq., p. 75 et seq.,
p. 81 et seq., see also the OECD’s Sectoral Guidance.
41
comply with the obligations (enforcement). The following considerations/building blocks
were taken into account when deciding about the retained options to be further analysed:
Personal scope Material scope Enforcement
Company size, sector:
- although entities beyond
limited liability companies
may do harm, it is difficult
to legally define these
entities
- even if only companies
of a certain size are in the
scope, due diligence has
impact on other
companies in the group
and in the value chain
(trickle-down effect)
- complementarity with
CSRD scope as it includes
the reporting obligations
required also under due
diligence
- companies with higher
risk of adverse impacts
should pay specific
attention to those risks.
These are companies of a
certain size and others
operating in high-impact
sectors
Non-EU companies:
- should be covered if they
generate relevant turnover
in the EU, even if not
established in the EU
Business relationships:
- need to build on existing
international voluntary
frameworks that are known to
many companies and on
existing voluntary initiatives
that companies have invested
in
- take into account the
existing EU sectorial due
diligence law
- the scope of due diligence
should reflect the fact that
most adverse impacts happen
beyond direct contractors,
further down in the value
chain
- however, as it is more
difficult to receive reliable
information, prevent and
cease adverse impacts beyond
direct contractors, including
to build leverage if necessary,
the due diligence duty should
only require to take
reasonable steps beyond
direct contractors
Impact categories:
- due diligence may be
limited to specific adverse
impacts and related risks (e.g.
forced labour), or cover full
human rights and
environmental adverse
impacts and related risks
- gradual approach adapted to
the financial capabilities of
companies: full human rights
and environmental due
diligence for larger
companies only; reduced
scope of impacts for smaller
Administrative
enforcement
- should be effective,
including for certain third
country companies that
generate a significant
turnover in the EU,
therefore sanction regime
could go beyond fines
Civil liability
- Remedying harm is
already expected from
companies based on
international voluntary
policy frameworks and
emerging jurisprudence
suggests that mitigating
adverse climate change
impacts throughout the
group and the value chain
is part of companies’
standard of care vis-a vis
others and society the
breach of which needs to be
repaired
- Civil liability should be
based on non-compliance
by the company with the
legal obligation to perform
adequate due diligence
- liability needs to clearly
outline conditions under
which a company can be
held liable at different level
of operation (own
operation, subsidiary, direct
and indirect contractors)
- should not cover one-off
subcontractors beyond tier
1, for efficiency reasons
and as the impact
prevention or mitigation
may not have lasting effect
42
Personal scope Material scope Enforcement
companies; phasing-in of the
smaller companies
Contractual elements to
avoid passing on the burden
to SME suppliers and
fostering responsible
purchasing practices, as
human rights violations at the
supplier level are often rooted
in the buyers’ own
purchasing practices.
Accompanying measures at
EU and Member state level
to facilitate the
implementation and reduce
the costs combined with
supporting measures in third
countries
due to the temporary nature
of such relationships
Access to remedy
- overriding mandatory
provisions may be
necessary to ensure that due
diligence is applicable
irrespective of the law
applicable in cases of
damages occurred in third
countries under current
private international law
Policy options retained for further consideration
As explained in detail in Annex 13, the policy options retained for a detailed analysis are
combinations of different approaches regarding the personal scope and the material scope
(content of the due diligence obligation) and of different enforcement mechanisms:
Personal scope: Due diligence requirements cover limited liability companies. Policy
options vary in terms of both size of the company and the industry sector of the
company’s activities to reflect proportionality.
The definition of company sizes will build on the definitions in the Accounting
Directive.218
However, we introduce additional categories for very large LLC companies,
which are defined either (i) as having more than 1000 employees (option 2), (ii) as
having 500 employees or more219
or a turnover of more than EUR 350 million (option
3a), or having 500 employees or more and a turnover of more than EUR 150 million
(option 3b). Complementing these, a category of midcaps is also used, where relevant, to
differentiate companies that exceed the medium-sized limits but are not very large.
218
Directive 2013/34/EU, according to which the limits of at least two of the three criteria mentioned in
each company category must not be exceeded for a company to fall in the category: Micro-undertakings:
10 employees/0.7 MEUR turnover/0.35 MEUR balance sheet; small undertakings: 50 employees/8
MEUR/4 MEUR; medium undertakings: 250 employees/40 MEUR/20 MEUR; large undertakings: 250 -
1000 employees or turnover above 40 MEUR/20 MEUR balance sheet. These definitions are used where
the scope is aligned with the CSRD proposal, while in other cases the definition is simplified (relying only
on employee and turnover data).
219
For very large companies with 1000+ employees and 500+ employees, the turnover thresholds are based
on the EU Directive on Unfair Trading Practices in agricultural and food supply chain.
43
To avoid undue administrative and financial burden, both micro-companies and small
companies are excluded from the scope of all options analysed, except for small (but not
micro) listed companies (which are included in option 4 to align the scope of the full due
diligence obligation with the scope of the sustainability reporting obligation under the
CSRD proposal). Still, some of these will be indirectly impacted as part of the value
chain by a trickle-down effect, i.e. when the larger EU company implements its due
diligence obligation and asks its value chain to comply with its sustainability
requirements.
Due diligence requirements will also apply to companies without an EU establishment
but operating in the EU and having generated a certain significant turnover in the EU.
The relevant threshold would need to be selected to constitute an adequate turnover that
sufficiently connects to the EU territory220
having also regard to the option eventually
selected for EU companies.
Depending on the scope of the different options, certain companies – other than those
subject to the full due diligence duty and those that are value chain partners or
subsidiaries of these – operating in high-impact sectors will be subject to targeted and
simplified due diligence obligations.221
The companies under this regime will have to
identify, prevent and mitigate their most relevant adverse human rights and
environmental impacts only for selected impact categories222
.
Content of the due diligence duty: The policy options that have been retained for
analysis in this report vary depending on the sectors or impact categories covered (theme-
specific, i.e. covering only selected impacts, or horizontal covering all sectors and human
rights impacts223
and environmental impacts224
), and the extent to which specific
categories of companies have to fulfil the due diligence obligation.
220
The turnover generated in the EU would (together with the operations in the EU) establish the
connecting factor with the EU territory required to cover third country companies (principle from the Lotus
Case, PCIJ, 1927). Employee figures would not be relevant in this context.
221
Such high-impact sectors would need to be identified and regularly reviewed as necessary. An
indicative “maximum” and more limited lists of possible high-impact sectors are provided in Annex 11.
These sectors have been selected based on the EU ETS, EU Benchmark regulation, national lists of risky
sectors from a human rights perspective and other criteria, as explained in that annex.
222
For example, chocolate company could be expected to focus on: right to life, child labour, climate
change, biodiversity, forced labour; a textile company would be expected to focus on forced labour, health
and safety, living wage, pollution, climate change; a chemicals company would be expected to focus on
pollution through discharge of chemicals, biodiversity, climate change, health and safety, forced labour. To
ensure legal certainty, it would be needed to specify which harms are the most relevant in a given sector in
line with and also feeding into the work on the CSRD reporting framework, which will also focus on
identifying issues relevant for determining sector-specific impacts. This would mean that first the high
impact sectors would need to be identified, then the relevant impacts.
223
See Annex 17. For the sake of completeness, human rights violations include any environmental
damage, in particular harmful soil, water or air pollution, harmful noise emission or excessive water
consumption, that impairs the natural basis for the preservation and production of food, denies access to
safe drinking water, impedes access to sanitary facilities or harms the health of a person. See Section 2(2)
No. 9 of the German Supply Chain law.
44
Human rights impacts are understood as the violation of human rights contained in
international human rights conventions. Environmental impacts are those specified in
selected international environmental conventions which contain duties that are
implementable for companies.
The due diligence obligation will cover the whole value chain.
Accompanying measures, help desk and training services, industry collaboration, multi-
stakeholder initiatives, use of modern technologies can facilitate companies’ due
diligence through their value chain. Additional support will be provided for value chain
actors in producer countries through development policy. By lowering the risk of doing
business with local suppliers in developing countries, this support will also immediately
benefit EU companies225
. Besides, the liability regime will be adapted to the difficulties
companies may face in long and complex value chains.
Proportionality of the due diligence process will be ensured through different elements.
On the one hand, depending on the option, specific companies operating in high-impact
sectors would fall under a targeted risk-based regime. Each option will be combined with
elements to limit passing on the entire compliance burden to value chain partners,
especially SMEs.226
Reporting to the public on the value chain due diligence processes and outcome of
prevention and mitigation measures will fall under the CSRD, as regards large companies
and listed SMEs, and will be made based on the CSRD reporting standards, where
applicable. As reporting applicable to high impact medium-sized companies would not
fall under the scope of the CSRD, it will be needed to define these required reporting
rules.
Enforcement: All option packages include both civil liability and administrative
enforcement by national authorities (complaint-based and ex officio investigations,
fines).
Regarding civil liability for failure to comply with the legal obligation to carry out due
diligence and thereby causing harm directly or indirectly, no policy options have been
retained which would not include civil liability or would limit civil liability to harm
caused at the level of the direct supplier as explained above. However, under all options,
224
An environmental impact is the likelihood of a violation of one of the prohibitions set out in the
environmental agreements listed in Annex 17. The list includes six specific agreements creating concrete
obligations that can be complied with by individual companies. All those international agreements have
previously been used in EU/national legislation creating individual obligations for economic operators.
225
For more details on supporting measures see Annex 18.
226
For instance by requiring that the business partner’s interests is taken into account in directors decisions
including when discharging the due diligence obligation and limiting imposition of unjustified costs in
contracts, or by identifying a black list of elements that cannot be put into contracts to enforce the due
diligence obligation and establishing model/standard contractual clauses (as done for the GDPR).
45
specific conditions apply for civil liability beyond tier 1. Only foreseeable risks may
trigger liability.
The company will be liable for the harm that could have been ceased or prevented in its
own operation and its subsidiaries where the company has ownership control, and at the
level of direct suppliers/relationships where the company has control through contract or
financing.
The lead company will also be liable beyond direct suppliers if it did not take reasonable
steps to cease or prevent the harm, for example by requesting its suppliers through
contractual clauses to ensure the cascading of the obligations, or preventing the harm
through engaging in industrial schemes or by using financial means (considered as
‘reasonable steps’). The burden of proof will not be regulated.
Third-country companies could be required to appoint a legal representative in the EU for
the purpose of administrative supervision.227
They will be subject to the same civil
liability regime as EU companies.
Administrative supervision and a proper sanction regime - which is also effective against
third country companies whilst not discriminating between third country and EU
companies - will be foreseen. Such enforcement could rely, for instance, on “naming and
shaming”, imposing fines, or banning from public procurement contracts.
Other sanctions, such as withdrawal of products from the market linked to a serious
adverse impacts, might be considered, however it requires questions of feasibility,
proportionality and compatibility with a horizontal nature of this company law initiative
to be addressed. Given that due diligence applies across a range of risks that are assessed,
prioritised and mitigated by the company in the risk-driven exercise, it would necessitate
establishing a link between the horizontal due diligence and a specific product (e.g.
because such product area had been the subject of objectively important and specific risk
indicators which a company had ignored). For instance, in proposed or existing Union
legislation, such as for batteries, a certification mechanism is used to enable supervisory
authorities to verify the conformity of product with certain requirements Such
mechanisms have to date typically been established in a product legislation.
Collaboration among enforcement authorities is in particular important to avoid uneven
application across the single market.
The following table summarises the policy options retained for assessment in this report:
227
The proposal for a Digital Services Regulation requires a point of contact and a legal representative for
supervisory purposes. The proposal for a Regulation concerning batteries and waste batteries, that
establishes a due diligence obligation of economic operators that place certain industrial batteries on the
market, requires that a manufacturer of a battery that is not established in a Member State may only place
the battery on the EU market if the manufacturer designates a sole authorised representative who is
considered the economic operator.
46
A detailed presentation of the options can be found in Annex 13.
Option 1: Sector specific (option 1a) or theme-specific (option 1b) mandatory DD
Personal and
material
scope:
 Sectorial approach: all large and medium-sized (i.e. all with 50+
employees and EUR 8m+ turnover), and (non-micro) listed LLCs in
the specific sector
 Theme-specific approach: large (250+ employees or EUR 40m+
turnover), medium-sized in high-impact sectors, and (non-micro)
listed LLCs for the specific theme
Enforcement: - Administrative supervision
- Harmonised civil liability for own operation, direct suppliers and
established business relations (i.e. excluding one-off relations) beyond
tier 1 with specific conditions when liability is triggered (see above)
- Access to remedy, i.e. possible overriding mandatory provisions as
regards applicable law.
Option 2: Horizontal DD obligations only for very large companies
Personal and
material
scope:
- Very large LLCs (1000+ employees) and third-country companies
(with significant turnover in EU) : mandatory DD
- Other companies: Not covered by mandatory DD, supporting
measures for those indirectly affected, elements to limit passing
compliance burden on to smaller companies in value chain.
Enforcement: same as in option 1
Option 3: Horizontal DD obligations combined with targeted regime for midcaps
and medium-sized companies in high-impact sectors
Personal and
material
scope:
 Option 3a:
- Very large LLCs (500+ employees OR EUR 350m+ turnover) and
third-country companies (with significant turnover in EU): mandatory
DD
- Medium-sized and midcap LLCs (50 to 500 employees OR EUR
8m to 350m turnover) in high-impact sectors: mandatory DD limited
to selected impact types (risk-based approach) and phased in.
 Option 3b:
- Very large LLCs (500+ employees AND EUR 150m+ turnover) and
third-country companies (with significant turnover in EU): mandatory
DD
- Medium-sized and midcap LLCs (50+ employees and EUR 8m+
turnover but smaller than very large companies with 500+ employees
and EUR 150m+ turnover) in high-impact sectors: mandatory DD
limited to selected impact types (risk-based approach) and phased in.
Enforcement: same as in option 1
Option 4: Horizontal obligation combined with targeted regime for medium-sized
companies in high-impact sectors – most wide-reaching approach
Personal and
material
scope:
- All large LLCs (exceeding 2 out of 3: 250+ employees / EUR 40m+
turnover / EUR 20m+ balance sheet total), all (non-micro) listed
companies and third-country companies (with significant turnover):
mandatory DD
- Non-listed medium-sized LLCs (50 to 250 employees and EUR 8 to
40m turnover) in high-impact sectors: mandatory DD limited to
selected impact types (risk-based approach) and phased in.
Enforcement: same as in option 1
47
5.2.2. Directors’ Duties
In order to attain the identified objectives of this initiative, evidence points to the need to
clarify that directors of limited liability companies, when acting in the best interest of the
company, should take into account the likely medium and long-term consequences of
their decisions and resolutions, and should also take into account the employee-related,
environmental and other stakeholder-related issues (alongside the interests of
shareholders). Such stakeholders include the company’s members or shareholders, its
employees (including those in the value chains), local communities and other groups of
people that are affected by the company’s operations, as well as the local and global
environment.
In addition, this general duty would be specified as including the following duties:
 Identifying relevant stakeholders and their interests,
 managing risks to the company linked to stakeholders (“sustainability risks”),
including dependencies of the company linked to these stakeholders or
stakeholder interests, setting up and overseeing corporate risk management
systems. Stakeholder related/sustainability risks should be identified in a short,
medium and long-term time horizon and should also extend to the value chain;
 setting up and overseeing corporate due diligence processes, policies and
measures;
 incorporating stakeholders’ interest and sustainability aspects (risks,
opportunities, impacts) in the corporate strategy, including science-based targets
for greenhouse gas emissions` mitigation; and
 engaging with stakeholders.
Annex 13 provides a more detailed description of the directors’ duties concerned.
5.2.2.1.Discarded options: only non-regulatory measures
Non-legislative options could include enhancing voluntary steps by non-regulatory
measures or soft EU law instruments such as Commission-led or EU-funded
awareness-raising campaigns and trainings for directors, Commission Guidelines for
directors, or a Commission Recommendation for Member States to adjust the Corporate
Governance Codes or to clarify their national laws.
As the Non-financial Reporting Directive already requires disclosure on sustainability
risks and their management by certain large companies, and evidence shows that
mandatory reporting was not sufficient to mainstream good practices to a satisfactory
level, the effectiveness of non-legally binding intervention in addressing the problems is
likely to be limited. The consultation activities show some support for regulatory
48
intervention rather than for soft law, but also reveal differences in the views of
businesses228
.
Against this background, the possibility of clarifying directors’ duties in Corporate
Governance Codes, as suggested by certain stakeholders, has been carefully considered.
However, there are several reasons that lead to discard this option with regard to the
general duty of directors to act in the interest of the company. These include the limited
effectiveness in making the necessary paradigm shift because of the limited scope (only
EU companies listed on EU regulated markets) and “comply or explain” nature of the
Codes229
, and because the problems to be addressed are, at least partially, rooted in the
lack of clarity of national company laws that regulate the duty of directors to act in the
interest of the company. For the same reasons, other purely non-legally binding EU
solutions were discarded as well. Please refer for details to Annex 13.
5.2.2.2.Options including regulatory measures
All options retained for further assessment include the clarification of the general duty
of directors to act in the interest of the company in a legally-binding, EU regulatory
measure that would apply to the directors of all EU limited liability companies.
In order to find the most efficient and proportionate solution, options that restrict the
personal scope of mandatory application were considered, including with a
differentiated scope as regards specific duties (risk assessment, due diligence oversight,
strategy with science-based targets). Reduction of compliance burden was sought, also by
including an option for the specific duties to be promoted in an EU Recommendation
(except for risk management) and by phasing in the entry into force of the specific duties
for SMEs. The following table summarises key elements with regard to these key
aspects:
Personal scope Content
Company size, sector:
- The general duty should apply to all LLCs,
including to micro enterprises with limited
liability because this clarification concerns a
concept included in national company laws
which does not differentiate by size of
companies.
General duty:
- Is key to empower directors to balance
the short and long-term interests of the
company and make sustainability
investments, including affecting the value
chain. It reflects the legal tradition of
Continental Europe.
228
In the public consultation a large majority of overall respondents answering the relevant questions
expressed support or strong support for corporate directors being required by law to: identify and balance
stakeholders’ interests, manage the risks for the company in relation to stakeholder interests and identify
the opportunities, set up adequate procedures and measurable (science-based) targets to ensure impacts on
stakeholders are addressed and integrate sustainability risks, impacts and opportunities into the company’s
strategy, decisions and oversight. However, about half of the businesses disagreed with the need to clarify
the need to balance stakeholder interests in legislation. For more details see Annex 2.
229
Corporate Governance Codes are instruments based largely on incentivising through reporting, with less
binding nature than the NFRD, so their impacts are expected to be even more limited.
49
Personal scope Content
- The directors of companies facing greater
sustainability risks, having greater impact,
affecting more stakeholders, and having
bigger capacities should be required to do
more. These are large companies and
companies operating in high-impact
economic sectors.
Consistency with CSRD and a corporate
due diligence obligation:
- The scope of the duties related to due
diligence should be consistent with that of
the corporate due diligence obligation.
As regards specific duties related to risk
management and strategy, build on the
CSRD scope as that contains the reporting
obligations.
- The science-based green gas emissions`
mitigation target setting could be limited to
very large companies.
Non-EU companies:
- cannot be covered as the duties of their
directors are not governed by EU law.
- Necessary to frame all key decisions in
a company.
Specific duties:
- Risk management duty: duty to manage
stakeholder related risks to the company
should be self-standing, in line with the
double materiality concept of the CSRD
- Directors’ responsibilities regarding risk
and impact management, implementing
such processes and approving the strategy
are in line with EU corporate governance
traditions
- Sustainability should not be a separate
strategy but should be embedded into the
corporate strategy, in line with the CSRD
- The duty to engage with relevant
stakeholders could apply in a simplified
manner, in particular to smaller
companies.
4 policy option packages230
reflect different levels varying along the 2 key aspects. The
following table shows the duties of directors contained in each option package.
Options Applicable duties for the various company categories
Option 1  General duty is legally binding (mandatory) for all LLCs.
 Mandatory risk management duty for all large, and – phased in – for
non-micro listed SMEs and other (non-listed) high-impact medium-sized
LLCs (CSRD scope + high impact medium).
 All other specific duties set out in an EU Recommendation for large and
high-impact medium-sized companies.
Option 2  General duty same as in option 1
 Risk management duty same as in option 1
 Duty to set up and implement due diligence processes and measures,
and a strategy that includes science-based targets are legally binding
for all very large companies and for high-impact midcaps and medium-
sized companies (scope aligned with the middle-ground scope for
230
A complementary element to all options is the reporting to the public under the Commission’s proposal
for a Corporate Sustainability Reporting Directive (i.e. the revised NFRD).
230
When referring to micro enterprises, small, medium-sized and large companies (LLCs), these should be
understood as complying with the definitions of the Accounting Directive, unless otherwise specified in the
related corporate due diligence option.
50
Options Applicable duties for the various company categories
corporate due diligence: i.e. option 3)
Option 3  General duty same as option 1
 Risk management duty same as in option 1
 All other specific duties are also legally binding for all large, and –
phased in – for non-micro listed SMEs and other (non-listed) high-impact
medium-sized LLCs (CSRD scope + high-impact medium), except:
 Duty to set up and implement due diligence processes and measures
is legally binding as in option 2, and
 Strategy that includes science-based targets applies only to very large
companies with more than 1000 employees.
Option 4  General duty same as option 1
 All specific duties are legally binding for all large and – phased in – for
listed non-micro SMEs and high-impact non-listed medium-sized LLCs
(scope aligned with the most wide-reaching scope for corporate due
diligence: option 4)
5.2.3. Directors’ remuneration
A regulatory option introducing a general clause could be considered to ensure that
remuneration schemes facilitate or at least do not hinder compliance with the due
diligence and directors’ duties, applying to all companies in the scope of the initiative.
More specific regulatory options – which would most likely target listed companies in
line with the scope of the Shareholders’ Rights Directive – are not being considered in
this Impact Assessment at this point in time as it appears useful to first await the
application of that Directive. Non-regulatory options have been discarded from the outset
as they would necessarily be targeted at updating Corporate Governance Codes; the
weaknesses of this approach have been previously outlined.
6. WHAT ARE THE IMPACTS OF THE POLICY OPTIONS?
This section assesses the impacts of each of the non-discarded policy options identified in
the previous section for each main area covered by the initiative. For this, we first
identified and assessed the significance of the initiative’s possible economic, social,
human and labour rights impacts, and of its expected impacts on climate change, as
well as on the local and global environment more broadly. Such impacts include
direct and indirect, immediate and prolonged, one-off and annually recurring costs and
benefits for the company, for the economy as a whole, for the companies’ stakeholders,
for society, and they also include the costs of supervision and enforcement by the public
authorities. This mapping and the detailed assessment of the impacts is set out in Annex
4. The calculation of business compliance costs and the enforcement costs to be borne by
the public administration, is also included in the same annex.
We then assess the policy options for each of the three areas covered on the basis of the
detailed mapping and assessment of the impacts. Because the main difference between
51
the options retained for detailed assessment concerning due diligence and directors’
duties is the magnitude of the expected impacts (due to their larger or smaller scope of
application, depth of the requirements, their mandatory or voluntary nature and the
breadth of the enforcement regime), the assessment of the options already contains a
comparison drawn not only with regard to the baseline scenario but also to the more far-
reaching option(s). The assessment consists of the following steps:
(1) We analyse the effectiveness of the measures included in the option to show the
extent to which the option concerned would achieve the specific – and ultimately
the general – objectives of this initiative. While all three areas would contribute to
all specific and general objectives, not all of them have the potential to contribute
to each objective to the same extent. Accordingly, the assessment of the various
sets of alternative options focuses in particular on the following specific
objectives:
Options for means to attain them:
Specific objectives:
Due
diligence
options
Directors’
duties
options
Measures
on
remuneration
Bring clarity on what directors are expected to do to fulfil their
duty to act in the interest of the company and to integrate
stakeholder interests and the long-term interest of the company
into directors decisions

Foster the integration of sustainability risks (including from the
value chain) into corporate risk management processes, facilitate
management of dependencies and ability to react to change
 
Increase accountability for identifying, preventing and mitigating
adverse impacts, including in value chains, avoid fragmentation
of due diligence requirements in the Single market and create
legal certainty for stakeholders as regards expected behaviour
and liability;
 
Improve access to remedy for those affected by adverse
corporate human rights and environmental impacts;

Improve corporate governance practices to facilitate the
integration of sustainability into directors’ and company
decision-making (e.g. in the area of stakeholder involvement).
 
(2) We analyse the costs of each policy option, taking into account the mapping and
the calculations provided in Annex 4 for companies as well as benefits.
52
(3) Then we also explain the expected impact on the broader economy, as well as
environmental, social and fundamental rights impacts that have not yet been
taken into account under the effectiveness and the cost assessment.
(4) We assess the efficiency of each option by weighing its effectiveness in reaching
the objectives and other positive impacts (benefits) of the option against its
expected costs. Proportionality of the identified options is taken into account in
the efficiency assessment.
(5) We then address the coherence with the other main areas covered by the initiative
and with other EU policies where appropriate.
(6) Finally, we assess the stakeholders’ feedback submitted to the open public
consultation that are relevant for the various options.
In general, the impacts will not be counted twice in the case of directors’ duties closely
related to the company’s due diligence obligation.
6.1. Corporate due diligence requirements throughout the company’s own
operations and in its value chains
6.1.1. Effectiveness
The following table summarizes our findings on how effective the four options would be
in reaching the relevant specific objectives, using a scale from – (not effective at all) to
++++ (very effective), compared to the baseline (scoring 0s everywhere):
Options:
Specific objectives:
1 2 3 4
Foster the integration of sustainability risks (including
from the value chain) into corporate risk management
processes, facilitate management of dependencies and
ability to react to change
-/+ + +++ +++
Increase accountability for identifying, preventing and
mitigating adverse impacts, including in value chains,
avoid fragmentation of due diligence requirements in
the Single market and create legal certainty for
stakeholders as regards expected behaviour and liability
-/+ ++ +++ +++
Improve access to remedy for those affected by adverse
corporate human rights and environmental impacts
-/+ ++ +++ ++++
Prevent and reduce adverse human rights (including
labour rights) and environmental impacts of EU
companies and their value chains worldwide
-/+ ++ +++ +++
53
6.1.1.1.Option 1:
Option 1 would entail a sector- or theme-specific approach. It would be similar to the
method of various EU measures which already set out certain due diligence obligations
or which are currently being prepared231
, addressing specific sustainability concerns that
are present in a specific sector or that are related to specific products.
This option would make a limited contribution to achieving some of the specific
objectives but could not ensure that any of the objectives are fully met. The principal
limitations would be as follows:
- The majority of industry sectors or, depending on the case, sustainability impacts
would not be covered by the due diligence duty. However, risks of adverse
impacts on the environment and on human rights are present in many industries’
global value chains, not only in the most salient sectors. Moreover, global value
chains typically embody more than one or a few sustainability impacts. The above
specific objectives would be achieved for the regulated theme or sector only.
- The approach would not prevent a multiplication of diverging national horizontal
due diligence regimes. Several EU Member States/EEA countries have already
adopted horizontal due diligence laws. Others, like the Netherlands, are working
on a horizontal legislative initiative that would be adopted in the absence of an
EU legal framework. Still other Member States, for instance Sweden and Finland,
are likely to start working on a horizontal due diligence instrument in the absence
of EU rules. The increasing fragmentation of due diligence requirements across
sectors of industry, Member States and areas of application would create lack of
legal certainty for companies and stakeholders.
- Stakeholders affected by human rights and environmental harm would have
access to remedies for the limited theme or in the regulated sector only.
Compared to the other policy options, option 1 would be least effective in terms of
reaching the specific objectives of this initiative.
There is a strong consensus amongst stakeholder groups that a horizontal EU framework
is necessary to address the identified problems. 92% of respondents indicated that they
prefer a horizontal approach as regards the content of a possible corporate due diligence
duty over a sector-specific or thematic approach.232
231
The EU Timber Regulation, the Conflict Minerals Regulation, the proposal for a Batteries Regulation,
the Deforestation initiative and the Sustainable Product initiative, as explained above.
232
This is true also for Member States respondents. 13 respondents (from Belgium, Czechia, Estonia,
Finland, France, Germany and Spain) prefer a horizontal approach. One respondent from Luxembourg
prefers a thematic approach. One respondent from Italy and one from Netherlands think that none of the
provided options are preferable.
54
6.1.1.2.Option 2:
This option would make a moderate contribution to achieving the specific objectives.
Around 8 900 companies would be in the scope of this option and companies in their
value chains would be indirectly impacted.
For this number of companies, this policy option would contribute to the specific
objectives of this initiative. However, the effectiveness of this option has limitations:
- A third of very large companies already carry out human rights and
environmental due diligence, albeit do not always cover all their value chain.
- While companies in the value chain of the companies in scope will be impacted
indirectly, the large majority of companies will continue not sufficiently
integrating sustainability risks (including from the value chain) into corporate risk
management processes, nor benefit from better managing dependencies.
- Accountability for identifying, preventing and mitigating adverse impacts,
including in value chains will not be increased for the large majority of
companies.
- The vast majority of EU companies will not get more clarity about what is
expected from them as regards addressing sustainability impacts in their value
chains and the circumstances under which they possibly may be held liable, as
international voluntary standards would remain the only benchmark for them and
those do not differentiate between company sizes.
Therefore, the limited scope of this option would result in its being only moderately
effective in contributing to the specific objectives of this initiative.
6.1.1.3.Option 3:
This option, through its design along two variables, employees and turnover, thus more
representative of capturing relevant companies, and its additional scope covering also
companies operating in high-impact sectors, would make a more effective contribution to
achieving the specific objectives of this initiative, with variations depending on the sub-
option.
The reference to turnover filters would also ensure that the companies having more of an
impact on the economy would be captured (whilst not being the only proxy of the
company’s economic impact, turnover is considered a good proxy of such impact and is
used in other pieces of Union legislation to this effect).
500+ employees is a reliable benchmark for capturing companies of a sufficient size and
companies above 500 employees generate 59% of the overall turnover of limited liability
companies in the EU.
Sub-option 3a targets companies that have more than 500 employees or generate a
turnover of at least 350 million. This would capture smaller companies with substantial
55
turnover [possibly as from 250 employees]. Around 23 000 companies would be covered,
accounting for around 38% of large limited liability companies in the EU233
.
Sub-option 3b targets companies that have more than 500 employees and generate at
least 150 million turnover. This would target only those companies that generate a
sufficient impact in their supply chains. Given that it is a double filter, the turnover is
lower than in option 3a. This cumulative criteria would capture around 9 400 companies.
This would result in covering 15% of large limited liability companies. In terms of
number of companies, this is a slightly broader scope than option 2; at the same time, it
represents a broader diversity among the companies covered in terms of operational and
financial capacity.
Subsidiaries and value chain business relations of these companies will also be indirectly
impacted.
Under both scenarios, in addition to the group of companies fully in the scope of the due
diligence duty, large companies between 250 and 500 employees and medium-sized
companies (50 employees),234
operating in high-impact sectors, would be included in the
personal scope of the initiative. This approach allows to capture medium to large
companies which, because of operating in sectors representing higher risk from a human
rights and environmental perspective, are likely to have significant individual or
cumulative adverse impact. The combination of such size and qualitative criteria is
justified by proportionality: smaller high risk or larger low risk companies are not
covered. This additional group of companies ranges between 9 520 to 46718 individual
companies as per sub-option 3a and between 10 199 to 49 486 individual companies as
per sub-option 3b, however part of these companies are not likely to incur additional
burden as they are a member of the group of the first category of companies, and as they
will be impacted indirectly by the obligation applying to the first category company, see
explanation in Annex 11. In total, options 3a and 3b would cover maximum 55 900 and
44 000 companies (indirectly affected subsidiaries of large parent companies are not
included). This leads to a significantly more effective contribution to the objectives of
this initiative than options 1 and 2, which at the same time remains targeted at highest
impacts in terms of turnover and risks.
This option could therefore effectively contribute to reaching the specific objectives of
this initiative.
6.1.1.4.Option 4:
This option has a wider personal scope than options 2 and 3. Under option 4, 65 000
individual companies would be covered, which represent 49000 company groups. They
account for 85% of large limited liability companies in the EU as defined by the NFRD.
233
Calculating with 60000 large limited liability companies on the basis of Orbis data.
234
Number of employees is combined with thresholds of annual turnover.
56
These companies account for 76% of the turnover of EU limited liability companies. In
addition, as under option 3, all other limited liability companies that are at least medium-
sized and operate in a high-impact sector would be in the scope, i.e. an estimated range
from 5 717 to 28 732, but only part of these would bear additional costs. Consequently,
maximum 85112 companies (indirectly affected subsidiaries of large parent companies
are not included) would bear additional costs. This option would cover virtually all large
limited liability companies, plus high impact medium companies, and thus may go
beyond what is necessary to reach this initiative’s objectives, given that much impact is
passed through the value chain. A turnover filter at lower level (40 million) does not
allow to effectively focus on companies with highest impact in the value chains.
Options Effectiveness
Option 1 +
Option 2 ++
Option 3a +++
Option 3b +++
Option 4 +++
6.1.2. Costs
6.1.2.1. Business compliance costs
The due diligence obligation will include one-off (initial) and recurrent (annual) costs. A
comprehensive assessment of the compliance costs and calculations are included in
Annex 4, this section only gives a summary of the cost analysis.
The compliance costs will consists of three main parts:
1) The costs of establishing and operating the due diligence processes and
procedures. These costs include, first of all, the cost of impact mapping and tracking:
collecting data to initially identify actual and potential adverse impacts in the company’s
own operations and in its value chains, analysing such information, monitoring the
development of such impacts and tracking the effectiveness of actions taken to reduce
adverse impacts where such impacts have been identified. Costs will also be implied by
the need to better control the supply chain (for example through contracts), possibly also
by taking part in collective engagement, and to incorporate human rights and
environmental sustainability standards in contracts with suppliers and other business
partners or to develop suppliers’ codes of conduct. These costs are both one-off and
recurring costs and Annex 4 analyses such cost impact quantitatively.
2) Transition costs, i.e. the expenditures and investments necessary to change the
company’s own operations and value chains in order to comply with the due
diligence obligation to cease and mitigate actual and prevent potential harm. These
costs are particularly relevant for companies that identify actual or potential adverse
impacts. They will need to undertake further steps to enforce the contractual terms and
standards enshrined in codes of conduct, to exercise the leverage over the value chain,
57
possibly to reorganise their upstream and downstream supply chains. As a last resort,
companies may need to terminate relationships with non-cooperative or non-compliant
suppliers and switch to new suppliers complying with the required standards. Companies
may also need to adjust their production processes, products or services. For instance,
they may need to invest into climate-friendly or resource-efficient production processes,
into research and innovation, into human capital, or upgrading facilities, etc. They may
possibly need to change their business models. Most of these costs constitute one-off
costs but companies would not necessarily incur them immediately after the entry into
force of the rules. Instead, they are likely to be spread across several years, in particular
where the due diligence duty requires achieving a result through gradual implementation,
for example in the case of climate change mitigation. As such costs depend on the current
individual circumstances of the companies which are difficult to control, Annex 4
assesses such costs qualitatively, with exemplary quantitative data to demonstrate such
effects.
3) Cost of reporting to the public: while there would be no additional reporting costs
for companies which are required to publish the necessary information under the revised
NFRD (CSRD), others – i.e. non-listed high-impact medium-sized companies – would
incur some reporting costs as a result of this initiative.
The assessment of the compliance costs takes into account the following considerations,
among others:
- Certain companies already perform some kind of due diligence and have risk
management processes, even if limited, including because of existing obligations
under social and environmental legislation. Supplementing already existing
processes costs less than establishing new ones. On the other hand many
companies which already perform due diligence often go until their first tier
suppliers only. Therefore companies with existing processes may also incur
substantial additional costs.
- The reporting obligation under CSRD would require setting up some basic
processes of information gathering and analysis which partly overlap with
the due diligence obligation. Such overlap is accounted for.
- Companies falling under a simplified regime may incur lower costs, while
many of those do not do any due diligence today and are therefore required to set
up most processes, even if they cover only more limited risk areas.
- Many factors contribute to reducing costs substantially, including industry
collaboration and modern technological solutions.
Furthermore, the transition costs and therefore the overall cost burden will be different
depending on the business model of the companies and the extent to which they have
already embedded in their organisation sustainability considerations as well as a certain
awareness of the impact of their activities on human rights:
58
- The costs are expected to be lower for companies that rely on suppliers which
themselves carry out sustainability due diligence.
- Conversely, companies with certain business models (for example the provision
of the lowest cost goods, high-speed delivery that places pressure on warehouse
workers, land use in countries where ownership rights may be contested, etc.) are
likely to incur more costs.
- Companies with more business partners, longer and more complex supply chains
or value chains that are not transparent or located in countries with lower human
rights and environmental standards are likely to incur higher compliance costs.
Some companies (subsidiaries, value chain partners) that are not under the scope of the
initiative would bear higher trickle down costs in particular in case they operate in high-
impact sectors or are selling their products or services, directly or indirectly, to larger
companies operating in high-impact sectors. However, under the due diligence obligation
safeguards will be provided so that large companies do not impose unjustified
compliance burden on their SME value chain business relationships. Large companies
could thus be incentivised to share information or cooperation platforms, etc. with its
suppliers which in turn could lower the cost for anybody else in the chain.
Based on the calculation of Annex 4, the following table summarizes the compliance
costs for individual companies, based on the different scope options:
Total direct incremental compliance costs of
mandatory DD (without transition costs) in
EUR:
Recurrent costs One-off costs
Micro LLCs,
Small LLCs,
Medium-sized LLCs not in high-impact sectors
Not covered, only indirect costs
Listed SMEs (full due diligence, covered only
in Option 1 and 4)
22 950 6 300
Medium-sized LLCs in high-impact sectors
subject to the targeted due diligence obligation
24 200 7 250
Midcap LLCs (“moderately” large) in high-
impact sectors subject to the targeted due
diligence obligation
39 150 11 100
Large and very large companies (including
midcaps where subject to full due diligence
obligation)
52 200 – 643 300
(cost numbers at
the upper end of
this range
estimated for
about 300 largest
LLCs only)
14 800 – 190 300
(cost numbers at
the upper end of
this range
estimated for the
about 300 largest
LLCs only)
*One-off costs are not immediate costs and can spread across several years.
59
For medium-sized companies and listed SMEs, these costs amount to about 0.09 to
0.10% of their revenue, and for midcaps, large and very large companies to about 0.004
to 0.006%.
The following table present the estimated direct compliance costs as per scope options
taking into account the number of companies affected:
Aggregate
d direct
business
complianc
e costs
(in EUR)
Option
1a:
Sectoral
e.g. C13
subsector
(manuf.
of textile)
Option
1b:
Thematic
approach
(one
impact in
all
sectors)
Option 2
(Horizonta
l full DD
only for
very large
with 1000+
empl.)
Option 3a
(+ targeted
DD for
high-
impact
midcaps &
medium-
sized
targeted)
Option
3b
(+
targeted
DD for
high-
impact
midcaps
&mediu
m sized
with
different
definition
for
midcaps)
Option 4
(full DD for
CSRD scope
+ targeted
DD for
high-impact
midcaps &
mediums)
Recurrent 0.06 bn 0.63 bn 0.64 bn 2.37 bn 1.72 bn 4.09 bn
One-off 0.02 bn 0.18 bn 0.18 bn 0.68 bn 0.50 bn 1.17 bn
6.1.2.2.Supervisory costs for public authorities
Public authorities will have to monitor and enforce compliance with the due diligence
obligations and handle situations in case non-compliance is identified through ex officio
investigations or based on complaints. These actions impose costs to public authorities.
Member States may designate one or several existing authorities as competent under this
initiative (involving authorities responsible today for human and labour rights and for
environmental matters) but they may also decide to set up a new authority that is
competent to deal with due diligence-related questions (including checking the strategy
and the targets) for all sustainability aspects.
Rather than calculating the costs on the basis of the examples of the existing instruments
at EU level, where the authority does not have the same role235
, we estimate the
supervisory costs relying on the recent detailed estimations of the German government
235
“Conflict minerals” Regulation or Timber Regulation.
60
that supported its draft bill on corporate due diligence in supply chains236
, making the
necessary adjustments: we take into account the difference in the sustainability aspects
covered (material scope) and also the broader personal scope, using proportionately
smaller costs, where relevant, for overseeing medium-sized and midcap companies, as
the German bill covers very large companies only.
The costs include one-off and recurrent labour costs and out-of-pocket costs (OOPC) for
the various risk-based steps of the supervisory tasks, starting from overviews and
plausibility checks of the information published by the companies on their adverse
human rights and environmental impacts and their due diligence practices (as part of the
sustainability reports disclosed under the SCRD or, for non-listed medium-sized
companies, under the reporting rules introduced by this initiative), through in-depth
assessment and reviewing supply and value chain management to on-site inspections237
.
The estimations include training costs and also the costs of administrative offence
proceedings. The general cost calculations apply to the systematic supervisory review of
large companies and SMEs (high-impact medium-sized companies and listed SMEs)
falling under the scope as per the various policy options. The detailed calculations are
explained in Annex 4, with the following table summarising the results:
Enforcement
costs in EU27 (in
EUR)
Option
1b238
Option 2 Option 3a Option 3b Option 4
Total recurrent: 8.00 million 2.51 million 11.24 million 7.86 million
19.52
mill.
Total one-off: 0.13 million 0.13 million 0.13 million 0.13 million 0.13 mill.
6.1.3. Benefits for companies
As explained in Annex 4, various meta-studies, including two recent ones, on the relation
between companies’ sustainability and financial performance demonstrate a positive
correlation between companies paying attention to their stakeholders’ interests,
sustainability risks, impacts and opportunities and their financial performance. This
positive correlation has also been confirmed by a large seminal meta-analysis of about
236
Referentenentwurf des Bundesministeriums für Arbeit und Soziales Gesetz über die unternehmerischen
Sorgfaltspflichten in Lieferketten, adopted by the Federal Government of Germany on 3 March 2021. The
law would apply to large companies with more than 3000 employees, and would focus on human rights
aspects, covering environmental factors to a limited extent.
237
As relevant disclosures become machine readable (including sustainability reporting under the revised
NFRD), which allows for deploying artificial intelligence more, supervisory costs could become lower.
238
In option 1a, for example covering subsector C13 (Manufacture of textile), the recurrent supervisory
costs would amount to about EUR 150 000.
61
2000 different sources239
. The positive impact of integration of stakeholder interests on
the company’s resilience in crisis situations too was confirmed in the Covid crisis240
.
The sources of such improved financial performance may be manifold: operational
efficiency, cost-saving, reputational gains, more attractiveness for talent, more
innovation, first-mover benefits in global markets. Annex 4 analyses available evidence
in greater detail. Not all benefits will arise immediately, most may manifest in the
medium to long-term. As explained in Annex 4, switching to low CO2-emission
technologies or more resource efficient technologies for example can be expected to
directly result in lower operating costs and can therefore bring cost efficiencies also in
the short-term but are generally expected to be a more profitable investment in the
medium to long run. For example a report from 2020241
shows the business case for low-
carbon investments. The study covering 882 European companies shows that emissions
reduction initiatives typically yield cost savings in excess of the initial investment at an
average profit of EUR 17 per tonne of CO2
242
.243
Companies also identified new revenue
opportunities from low-carbon goods and services – more than six times the investment
needed to realize them.
Not all potential benefits will arise equally to all companies in the scope:
- All companies (even those indirectly impacted) may derive performance benefits
linked to, for example, operational cost savings due to more efficient operations,
less reliance of scarce raw materials, better relationships with and trust from
stakeholders, better knowledge of the supply chain and its environment, better
commercial relationships, etc.
- Improved branding and reputational benefits, benefits arising from attracting
talent, etc. arise less when a large number of companies are subject to the new
rules, i.e. within the single market. However, as EU companies may be first
movers in global markets, they may derive these benefits on those markets.
239
See Friede, Busch and Bassen (2015) “ESG and financial performance: aggregated evidence from more
than 2000 empirical studies”.
240
See Cheema-Fox et al., 2020, Corporate Resilience and Response During COVID-19; OECD Centre for
Responsible Business Conduct note “COVID 19 and Responsible Business Conduct”; European Capital
Markets Institute’s Commentary ESG resilience during the Covid crisis: Is green the new gold?, 67-2020.
241
Doubling down Europe's low carbon investment opportunity, February 2020
242
While the companies anticipated more than 2.4 GtCO2e of cumulative emissions reductions over the
lifetime of their initiatives – more than the annual emissions of Germany, the United Kingdom, Italy,
Poland and France combined –, they also expected to achieve €65 billion of cost savings over the lifetimes
of their investments. Compared to their initial €24 billion of investments (in 2019) this represents a net €41
billion contribution to bottom line.
243
The most profitable emissions reduction initiatives were expected to be investments in energy efficiency
processes but significant abatement profits were also anticipated from investments in transport
electrification and low-carbon energy.
62
- Companies with more advanced impact management may derive less benefits but
may still benefit from cost savings linked to harmonisation, increased level
playing field, etc.
- Benefits related to cost of capital and financing are likely to increase over time in
light of ongoing measures requiring proper sustainability risk management in
banks and some other financial institutions and growing awareness about
sustainability risks in the finance sector.
However, benefits will not arise to those companies which cannot bear the initial
compliance burden, this risk has been reduced considerably in option 2 and 3 the scope
does not cover medium companies only if active in high impact sectors, it does not cover
small and micro companies, safeguards that large companies share the compliance
burden of SMEs, even if only indirectly impacted, different support measures, coverage
of third country companies, etc. (see in more detail under “efficiency”).
6.1.4. Environmental, social and fundamental rights impacts, and impacts on
the economy
For a complete analysis referring to available evidence, please refer to Annex 4.
As one major objective of this initiative is help delivering on the sustainability transition
and to have positive impacts on human rights, including labour rights, and on the
environment, only those options have been retained for further analysis that are at least to
a reasonable extent effective in reaching this objective. The magnitude of these beneficial
impacts increases with the scope of application to companies, impacts covered, extension
of the duty to the entire value chain and with the efficiency and credibility of the
enforcement mechanisms.
The human rights, including labour rights, and environmental benefits are closely
interrelated (for example environmental pollution can impact on people’s health and
access to food).
While all these impacts would benefit European citizens, workers, companies, and other
stakeholders in the EU, the rules have the potential to significantly benefit people,
companies, communities and the environment in the EU and third countries. For
example, mandatory due diligence is expected to lead to safer and more decent
working conditions for employees throughout EU companies’ value chains, such as less
forced labour, child labour or less exposure to hazardous materials or dangerous working
sites and overall health and safety related benefits.
The involvement of stakeholder groups can further increase awareness of companies of
their actual or potential adverse human rights, including labour rights, and environmental
impacts, which can contribute to the mitigation thereof.
63
The French law is considered to have resulted in fostering more awareness in host
countries about low human rights standards or insufficient enforcement244
and the EU
law is expected to have an even stronger impact on the local laws and enforcement
regimes in third countries, which would further increase benefits for vulnerable people.
As regards possible negative impact on human rights, including labour rights, and the
environment which may arise as a result of abandoning suppliers or territories affected
by, for example, systemic human rights issues, please see below in section 6.1.5.
While in the short-term, EU companies will be at a relative disadvantage in cost
competitiveness compared to non-EU companies in global markets, additional firm-level
costs as percentages of companies’ revenues are still relatively low.
On the other hand, the new EU legislation will decrease distortions between EU and non-
EU companies by creating more equal standards for EU companies, third country
companies generating a high turnover in the EU as well as EU and non-EU suppliers.
As in the mid to long-term, corporate benefits are expected to outweigh costs (in terms of
efficiency gains, more resilience, better financial performance through innovation, etc.)
and possibly also lead to first mover advantages in global markets (including securing
access to resources, technology, secure market shares in global markets and gain
economies of scale vis-à-vis later market entrants), the cumulative impact of these
benefits is expected to lead to competitiveness gains for the economy in the mid to longer
term. The measures are likely result in reduced dependency on scarce natural resources
and more resilience to sustainability related shocks.
Finally, the due diligence obligations imposed on companies does not have any negative
impact either on the freedom to conduct a business or to the right to property of the
shareholders. It sets the boundaries to business activities at the level of harm caused to
people and the environment.
6.1.5. Impacts on third countries and developing countries
By including European companies’ global supply chains into their scope, and by
recognising that the most salient adverse impacts on human rights and on the
environment occur mainly outside the EU, the policy options have a strong external
dimension through their impacts on supply chain actors and stakeholders in third and
developing countries.
The policy options can have a positive impact on third and developing countries by
preventing and reducing adverse human rights (including labour rights) and
environmental impacts of EU companies and their value chains worldwide. Developing
244
ILO report Achieving decent work in global supply chains, February 2020; France’s General Council of
Economy, January 2020, Evaluation de la mise en œuvre de la loi n° 2017-399 du 27 mars 2017 relative au
devoir de vigilance des sociétés mères et des entreprises donneuses d’ordre .
64
countries, where the risk of adverse social, environmental and governance impacts tend
to be highest, will benefit from meaningful engagement of EU companies with value
chain partners on identifying and mitigating these impacts. These benefits can
substantially be amplified through mutually reinforcing initiatives, including
development of voluntary sustainability standards, support of multi-stakeholder alliances
and industry coalitions, as well as accompanying support provided through EU
development policy and other international cooperation instruments.
A duty for EU companies to conduct human rights and environmental due diligence in
their own operations and global supply chains relations can, at the same time, lead EU
companies to prioritise risk avoidance through disengagement from suppliers and
producers in developing countries over meaningful engagement in risk prevention and
mitigation. The safeguards mentioned above regarding cost sharing with SME value
chain partners, the requirement that stakeholder interests (including value chain partners
and victim of an abuse) are taken into account in impact mitigation measures, etc.), and
the cost implications of restructuring value chains reduces the risk of abandoning third
country value chain partners.
6.1.6. Efficiency
The analysis looks at cost efficiency at company level and overall cost efficiency with
respect to all possible benefits.
Within the sector or theme specific option 1, the cost per company of a theme specific
due diligence obligation will be lower than due diligence applying to all impacts or most
relevant impacts. On the other hand, setting up due diligence processes for checking one
impact only is less cost efficient for the company, than setting up processes to cover
more or all impacts as the relative cost of extending existing processes to additional
impacts is lower. Therefore, from the perspective of company specific cost-efficiency,
the theme specific obligation is the least cost efficient. This is also true for overall
efficiency: with slightly lower overall cost impact than a duty applying to all themes,
much less benefits will accrue not only for companies but also for stakeholders, i.e.
as regards social and environmental impact. If the theme specific obligation applies
only to child labour there will not be any benefit for the environment and the social
benefits will also be limited.
As regards the sector specific option, the due diligence obligation would require
addressing all impacts in that specific sector, for example garment and footwear. The cost
implications for the company operating in the sector will be similar to the cost
implications of the horizontal duty per company, as all impacts will be covered.
However, a garment company could not benefit from the impact mitigation actions of
companies operating in other sectors. So, for example, if a company operating in the
automotive sector buys textile from the same supplier as the garment company, this latter
cannot share costs with the automotive company through cross-industry cooperation. For
the garment company the cost impact will be more considerable than if there are cross
industry cooperation possibilities. As regards overall efficiency, the sectorial option’s
benefits will mostly be limited to that sector.
65
While this option will have lower short-term cost impact on the economy, given the
comparatively very low positive economic, social and environmental benefits and low
effectiveness of this option to achieve the specific objectives, option 1 is least efficient
among all options.
Option 2 covers very large companies across sectors which are subject to full due
diligence. While only large companies are directly covered, their subsidiaries as well as
value chain members will also be indirectly impacted. As a third of very large companies
already do some form of due diligence but mainly limited to their tier 1 suppliers, these
companies could mainly benefit from the financial performance improvements (better
knowledge of value chain, dependencies, streamlining value chain, etc.) harmonisation,
increased level playing field and cost sharing with other companies under the scope.
As under this option, a smaller portion of companies will be directly and indirectly
impacted than in Option 3 or 4, fewer companies are likely to derive more benefits too,
than if more companies would be covered, as some benefits are relative to the
performance of the competitors. The companies under the scope could derive more
benefits from better reputation, better access to capital, attracting talent, but also financial
benefits from more efficient production processes, less risk, etc.
As regards overall efficiency of Option 2, the initial negative competitiveness impact on
the economy will be smaller. But the medium to long-term positive economic impact will
also be smaller as well as the overall social and environmental positive impacts and the
effectiveness of the option to contribute to the specific objectives. Companies that are not
directly or indirectly impacted will not derive benefits from their transition to more
sustainable production and operation, which, in the medium to longer term, will
negatively affect their operations and the economy. This option is effective only to a
limited extent to increase accountability for adverse impacts and improve access to
remedy due to its limited scope.
The scope of option 3 is larger than that of Option 2. This option combines the
advantage of covering companies beyond very large ones, thereby contributing to an all
economy transition, but applying a targeted approach in terms of turnover and risk which
avoids excessive burden on SMEs. Micro and small companies could only be indirectly
impacted and high-impact medium-sized companies and midcaps would fall under a
targeted due diligence regime which implies simplified requirements. This option thus
takes into account the constraints on EU businesses’ operations and profit margins in the
Covid crisis245
.
As regards cost efficiency at the level of the company, there may be economic benefits
which are felt more immediately, such as better knowledge and management of supply
chains, better awareness of dependencies (short-term gains). There are also economic
245
For more details on the effect of the COVID-19 pandemic, please refer to Annex 14.
66
benefits which may occur in a mid to long-term perspective, such as gains from increased
efficiency, environment-friendly investment or innovation leading to growth
opportunities, increased market share, other first mover advantages in global markets.
Having effective enforcement mechanisms in place (liability and administrative
supervision) might increase not only the compliance by companies but also the
credibility of their due diligence activities and parallel reporting. This could potentially
also increase the economic benefits arising from the initiative.
As regards certain medium companies but also other SMEs indirectly impacted, as the
initial cost burden is considerable and most benefits materialize in the mid-to long-term,
the content of the due diligence measure was carefully crafted to ease compliance and
respond to their specific needs. The measures are expected to foster cost sharing between
the large buyer and the small supplier, several support measures are being developed, and
high impact medium companies will only be phased in which allows for preparing for the
news rules. Furthermore, industry collaboration is likely to continue and further develop,
and SMEs can also benefit from the impact mitigation efforts of large companies which
get supplies from the same supplier as them. On the other hand, the short-term cost
impact may be significant in particular for medium companies notably for those which
are not part of the value chain of a larger company and cannot share costs through
industry cooperation.
As regards overall efficiency, while the short-term cost impact of this option on the
economy is significant, overall more economic benefits are expected in particular in the
mid to longer term. This assumption is in line with the views of respondents to the public
consultation (even businesses) which considered that benefits of due diligence outweigh
the costs. Furthermore, the benefits will spread more equally across sectors. Because of
the numerous measures aiming at reducing the risk of excessive burden on smaller
companies, it is not expected that the duty would have very significant negative impact in
the short-term on any parts of the economy. Furthermore, with the coverage of third
country companies making significant turnover in the EU, the initial negative cost
competitiveness effects on EU companies and on the economy will also be reduced.
This option 3 has a better score for effectiveness than Option 1 and 2 and will therefore
also result in more positive social and environmental impacts as outlined in section 6.1.4.
Taking into account the safeguards introduced to limit negative impact on companies
(both on large and small, both in the short and longer term) the potential of this option to
share costs more effectively across companies and across industry sectors thereby
increase per company cost efficiency, its efficiency rating therefore shall be higher than
those of the previous options but the efficiency of sub-option a) is more of less the same
as the one for sub-option b) as the difference in scope and thus the cost sharing
opportunities are not very significant.
Option 4 has its scope largely aligned with the CSRD and covers therefore the largest
share of LLC and of the Union economy. It would imply at least a double of the
compliance costs of option 3, while benefits may only be less high as some will
67
materialize even less per company when more companies are covered (such as for
example attracting talent, reputation) .
As certain economic benefits resulting from operational efficiency, innovation etc. do not
depend on a relative advantage vis-a-vis competing firms, but all firms can
simultaneously benefit from them as explained above, a broader application of a new
regulation could provide more benefits. Furthermore, it is likely that there will be more
cost sharing opportunities under scope 4 given the significant scope of coverage,
therefore per company benefits compared to costs could be even higher.
On the other hand, this option is not targeted as Option 3 in a sense that it may apply to
many more large or medium companies even if these present less risk, therefore the
overall benefits may also be lower. It is also more likely that the same suppliers would be
checked by many more companies, which reduces the overall efficiency of this option
also as regards human right and environmental benefits, compared to Option 3. For these
reasons the efficiency rating of option 4 should be lower than that of Option 3.
Options Efficiency
Option 1 +
Option 2 ++
Option 3a,3b +++
Option 4 ++/+++
6.1.7. Stakeholders’ views246
Mandatory due diligence rules have been called for from a broad range of stakeholder
groups, including civil society representatives247
, EU citizens248
, businesses249
as well as
business associations250
, who see benefits in an EU harmonised approach rather than the
current situation of emerging national initiatives.
246
For more detailed information on the results of the stakeholder consultation, please refer to Annex 2.
247
E.g. https://responsiblebusinessconduct.eu/wp/wp-content/uploads/2020/09/Principal-elements-of-an-
EU-mHREDD-legislation.pdf; https://cleanclothes.org/news/2021/fashioning-justice, etc.
248
A October 2021 YouGov poll shows that over 80 percent of citizens from across multiple EU countries
support strong laws to hold companies liable for overseas human rights and environmental violations.
249
https://www.business-humanrights.org/en/latest-news/list-of-large-businesses-associations-investors-
with-public-statements-endorsements-in-support-of-mandatory-due-diligence-regulation/.
250
E.g. Business for Inclusive Growth: https://www.b4ig.org/articles-all/b4ig-leads-the-way-on-the-
european-framework-on-mandatory-human-rights-due-diligence /; Federation of the European Sporting
Goods Industry: https://fesi-sport.org/wp-content/uploads/2020/10/FESI-position-paper-on-due-diligence-
July-2020.pdf; Amfori: https://api.fairwear.org/wp-content/uploads/2020/04/Responding-responsibly-to-
the-COVID-19-crisis-110520.pdf;.https://fesi-sport.org/wp-content/uploads/2020/10/FESI-position-paper-
on-due-diligence-July-2020.pdf; etc.
68
The results of the open public consultation251
follow suit252
, with respondents agreeing
that an EU legal framework for due diligence needs to be developed. 253
92% of respondents preferred a horizontal approach as regards the content of a possible
corporate due diligence duty over a sector specific or thematic approach.254
The most
preferred option was a minimum process and definitions approach, complemented with
further requirements255
.
52% of companies indicated that they feared the risk of competitive disadvantages vis-à-
vis third country companies that do not have to same duties. Therefore, 97% of
respondents across the board agreed that due diligence rules should also apply to third
country companies which are not established in the EU but carry out (certain) activities
in the EU.256
For those who recommend that the due diligence system should apply to
third country companies, most expressed that turnover generated in the EU should
determine whether third country companies are subject to EU legislation.257
Regarding an enforcement mechanism accompanying a mandatory due diligence duty,
71% of respondents across the board indicated that supervision by competent national
authorities with a mechanism of EU cooperation/coordination is the most suited
option.258
251
Summary of the open public consultation for the initiative on sustainable corporate governance.
252
Breakdown of responses by stakeholders groups is highlighted only in case of differences in the
opinions occur.
253
NGOs supported the need for action with 95.9%, companies with 68.4% and business associations with
59.6 %.
254
This is true also for Member States respondents. 13 respondents (from Belgium, Czechia, Estonia,
Finland, France, Germany and Spain) prefer a horizontal approach. One respondent from Luxembourg
prefers a thematic approach. One respondent from Italy and one from Netherlands think that none of the
provided options are preferable.
255
The order of preference differed in the case of individual companies and business associations which
preferred a minimum process and definitions approach without further requirements. Campaign
respondents expressed preference for a minimum process and definitions approach while petition
signatories in turn, prefer a minimum process and definitions approach complemented with further
requirements.
256
All Member State respondents agree with this statement as well. The respondents who didn’t express
agreement expressed their concern about the difficulty and unfeasibility of the procedure of a due diligence
rule applying also to certain third country companies which are not established in the EU but carrying out
certain activities in the EU.
257
To a lesser extent, other respondents think that (1) companies operating within EU borders, (2)
companies with a link to the EU market, (3) companies with parts of their supply chain located or active in
Europe, and (4) companies listed on EU stock markets should be subject to EU legislation. Finally, some
respondents refer to other legislation to determine what link should be required (e.g. the Timber Regulation
and Directive 2019/633 on Unfair Trading Practices).
258
It was followed by the option of judicial enforcement with liability (49%) and supervision by competent
national authorities based on complaints about non-compliance with effective sanctions (44%).
69
In relation to non-binding guidance and binding law all stakeholder groups indicated
binding law with targets as the option that entails the most costs259, however also the
most benefits overall260.
Some of the overall most cited benefits were reductions in adverse impact on human
rights, land and environmental defenders; safer and more decent working conditions for
supply chain workers including those in non-EU countries; reductions in incidents of
labour exploitation, human trafficking, other forms of forced labour, and child labour;
reductions in land grabs; improvement in the environmental impact of business
operations; creation of long-term and trust relationships through the use of meaningful
stakeholder engagement processes and progress towards the achievement of the
Sustainable Development Goals. Although most respondents can see the positive
elements on third countries, a subset of respondents fear a potential negative impact of
due diligence rules on third countries if companies investing in third countries with weak
social, labour, and environmental rules, would have to withdraw from these countries.
However this was indicated as one of the least preferred solutions for companies,
evidenced by the results of both the open public consultation261
as well as preliminary
due diligence study survey results262
.
6.1.8. Coherence
The due diligence duty is a crucial contributor to the success of many Commission
strategies aiming at implementing the UN SDGs and fostering sustainable value creation
and will support and render more effective other EU policies and initiatives on climate
mitigation, environmental protection, free and fair trade, better social and human rights
standards. Annex 7 explains the added value of the sustainable corporate governance
initiative compared to existing law and other initiatives in the pipeline and how it
interrelates with ongoing initiatives and complements them.
The sector or theme specific approach would be a somewhat less coherent option than the
others given that the sustainable products initiative is also meant to cover specific
products or product groups in specific sectors as explained in Annex 7.
6.1.9. Proportionality
Small and micro companies, accounting for around 98 % of LLCs in the EU, are
excluded from the due diligence duty under all policy options analysed. For this category
259
Administrative, litigation and other costs. Businesses and business associations gave the costs of
binding law with targets the highest rating, followed by NGOs and environmental organisations, EU
citizens and consumer organisations while trade unions give a low mean rating.
260
Performance, competitiveness, risk management and resilience, innovation and productivity,
environmental and social performance. Trade unions give the benefits of binding law with targets the
highest rating, followed by EU citizens and consumer organisations, while company/business organisations
and business associations rate these benefits lower.
261
For a more detailed overview please refer to Annex 2.
262
Study on due diligence requirements through the supply chain (2020), p. 16.
70
of companies, the financial and administrative burden of setting up and implementing a
due diligence process would be relatively high. For the most part, they do not have pre-
existing due diligence mechanisms in place, they have no know-how, specialised
personnel, and the cost of carrying out due diligence would impact them
disproportionately (they will still be exposed to certain extent to some of the costs and
burden through a trickle-down effect). At the same time, exposure of such small or micro
companies individually to sustainability impacts will as a general rule be lower than the
exposure of larger companies. Therefore, under options 2 to 4, only large to very large
companies would be within the scope of the full due diligence obligation, because both
their potential sustainability impact and their capacity to set up and implement due
diligence processes and to bear cost and administrative burden would be higher. In
particular, the selected turnover criteria in options 3 and 4 will filter in accordance with
the companies’ impact on the economy, with option 3 focusing on those companies
having the largest impact on the EU economy, and option 4 including also companies
with less impact. Moreover, there will be measures to limit the passing on the burden
from those large companies to the smaller suppliers in the value chain.
As far as companies with lower turnover/less employees263
are concerned, the due
diligence obligation is limited to companies active in particularly high-impact industry
sectors and their most relevant sustainability issues in options 3 and 4. This limitation
aims to create a balance between the interest in achieving the goals of the initiative and
the interest in minimising the financial and administrative burden on companies.
As regards private enforcement of the due diligence obligation, the policy options, which
include civil liability provisions going beyond harm done at the level of the direct
supplier, do not go beyond what is necessary. Effective enforcement of the due diligence
duty is key to achieving the objectives of this initiative. Civil liability is particularly
important in enabling victims to obtain a remedy for damage done. However, it will in
practice be difficult to prevent all risks through global value chains, which are
characterised by a multitude of layers and supply networks. It would therefore not be
proportionate to impose a duty making companies responsible for any harm that has
happened in the value chain. Options 1 to 4 limit liability to harm done in the value chain
beyond tier one to specific conditions. The options analysed thus aim at creating a
balance between the need for an effective enforcement regime and the need for
companies to operate with legal certainty.
The proposed measures in all policy options related to public enforcement of the due
diligence duty do not go beyond what is necessary either. They entail the national
supervisory authorities’ power to investigate and impose proportionate sanctions. Non-
compliance may also lead to “naming and shaming”, withdrawal of products and bans
from public procurement. The power of public authorities to supervise and impose
263
I.e., medium-sized and, under option 3, also large companies from 250 to 500 employees as those would
not be covered by the full horizontal due diligence duty.
71
proportionate monetary sanctions in case of on-compliance is key to an effective
enforcement regime.
Other sanctions, such as withdrawal of products from the market linked to a serious
adverse impacts, might be considered, however it requires questions of feasibility,
proportionality and compatibility with a horizontal nature of this company law initiative
to be addressed. Given that due diligence applies across a range of risks that are assessed,
prioritised and mitigated by the company in the risk-driven exercise, it would necessitate
establishing a link between the horizontal due diligence and a specific product (e.g.
because such product area had been the subject of objectively important and specific risk
indicators which a company had ignored). For instance, in proposed or existing Union
legislation, such as for batteries, a certification mechanism is used to enable supervisory
authorities to verify the conformity of product with certain requirements Such
mechanisms have to date typically been established in a product legislation.
Collaboration among enforcement authorities is in particular important to avoid uneven
application across the single market.”
In cases where administrative fines would be difficult to enforce vis-à-vis third-country
companies, such sanction could have a sufficiently deterrent effect on them.
Furthermore, this initiative does not entail unnecessary costs for the Union, national
governments, regional or local authorities. The Directive would leave it up to the
Member States to organise enforcement. Administrative supervision can be carried out
by pre-existing authorities.
6.2. Directors’ Duties
6.2.1. Effectiveness
Each option contributes to a variable extent – and more effectively compared to the
baseline – to meeting the initiative’s objectives. In line with the overall perception in the
public consultation namely that the more precise the duties are, the more effective they
will be in meeting the initiative’s goals and in bringing benefits, we can assume that the
more specific the duties directors have to comply with, the more effective an option will
be in reaching the objectives of this initiative. The more companies are within the scope
of the initiative, the greater the number of companies whose directors will incorporate
long-term and sustainability aspects in their decision-making. In this sense, the four
policy options are increasingly wide-reaching, with Option 1 contributing least and
Option 4 contributing most effectively to achieving the specific objectives of this
initiative.
The following table summarizes our findings on how effective the 4 options would be in
reaching the relevant specific objectives, using a scale from – (not effective at all) to
++++ (very effective), compared to the baseline (which has 0s everywhere):
72
Options:
Specific objectives:
1 2 3 4
Clarify what is expected of directors in order to fulfil
their duty to act in the best interests of the company
and to incorporate the interests of stakeholders and
long-term interests of the company into their decisions
++ +++ +++ +++
Foster the integration of sustainability risks (including
from the value chain) into corporate risk management
and impact mitigation processes and strategies,
facilitate management of dependencies and ability to
react to change
++ +++ +++ +++
Increase accountability for identifying, preventing and
mitigating adverse impacts
+ +++ +++ +++
Improve corporate governance practices to facilitate
the integration of sustainability into directors’ and
company decision-making (e.g. in the area of
stakeholder involvement)
+ + +++ ++++
6.2.1.1.Option 1:
Option 1 would make a limited contribution to reaching the objectives of this initiative. It
would partially achieve the objective of clarifying what is expected of directors in order
to fulfil their duty to act in the best interest of the company and to incorporate the
interests of stakeholders into directors' decisions. It would only make a partial
contribution to reaching the specific objective of integrating sustainability risks and
impacts into corporate risk management, impact mitigation processes and corporate
strategies, and to the specific objective of improving corporate governance practices to
facilitate the integration of sustainability into directors’ and company decision-making.
This option may not ensure that the duty to establish and carry out due diligence is
situated at the board level and that directors have to engage with stakeholders. As these
duties would be included into a recommendation only, the effectiveness of it would
depend on how many Member States implement it and how. Furthermore, if such
recommendation is transposed into “comply or explain” corporate governance codes
only, the scope of application may be limited to listed companies, and effective
implementation is not guaranteed.
Clarifying that stakeholder interests and the long-term interest of the company need to be
taken into account in decisions may already prompt proper identification of stakeholders,
their interests and managing stakeholder related risks. However, the fact that the rules do
not specify what exactly needs to be done could lead to uncertainties and limited
effectiveness. Furthermore, the specific duties in this option do not go beyond risk
management and the due diligence duty will not, in itself, ensure that directors will
consider that it is their responsibility to set up processes and measures, in particular, as
the liability for failure to carry out due diligence will be on the company. Therefore this
73
option is more effective in fostering directors’ focus on risks to the company and is only
effective to a limited extent to foster focus on impacts.
6.2.1.2.Options 2 and 3:
These policy options are slightly more effective than option 1.
Both options would be more effective in achieving the goal of clarifying what is expected
from directors as part of their duty to promote the interests of the company. They go
beyond risk management and include also duties to set up and oversee due diligence
processes and measures. Option 3 covers also the specific duties of integrating
sustainability risks and impacts into the corporate strategy and requiring stakeholder
engagement. Option 2 and 3 would therefore achieve more effectively that both
stakeholder related company risk and external impacts are tackled at directors’ level,
integrated into corporate governance processes, and option 3 will also ensure that
sustainability risks and impacts are considered as strategic and as such has a bigger
potential to affect the business model of the company. These options will also contribute
to increase accountability for identifying, preventing and mitigating adverse impacts, as
directors would be required to set up due diligence processes and measures. Option 2
and 3 will foster a more long-term approach with all the benefits it brings as explained in
Annex 4. Option 2 is more effective as it has a larger scope for the setting of corporate
strategy including the science based targets on climate mitigation. Option 3 also covers
stakeholder engagement which is a tool to effectively channel relevant stakeholder
interest into corporate decision-making.
6.2.1.3.Option 4:
By virtue of it containing all specific duties, this option would significantly contribute to
enhancing clarity and by its large scope it is effective to ensure more accountability of
directors. It would be effective in clarifying what is expected of directors in order to fulfil
their duty to act in the best interests of the company and to incorporate the interests of
stakeholders into their decisions and in fostering the integration of sustainability risks
into corporate risk management processes, facilitate management of dependencies. The
overall effectiveness of this option (also because of its coverage of issues and its scope)
is similar to that of Option 3).
Options Effectiveness
Option 1 +
Option 2 +++
Option 3 +++
Option 4 +++
6.2.2. Costs and other possible negative impacts on the company
The substantive requirements introduced for directors of European companies would
create additional compliance costs for the companies in accordance with the scope of the
various policy options. In most companies, internal processes and management systems
74
would need to be revised to ensure that directors are able to meet their clarified general
duty to promote the best interest of the company, and their harmonised specific
obligations.
The cost of setting up, operating and overseeing corporate due diligence procedures
to mitigate adverse sustainability impacts is already included in the cost calculations for
the corporate due diligence options.
Additional cost arising from the duty to identify all stakeholders and their interest
could be minimal as this would be relatively straightforward in the case of some
stakeholders (e.g. employees), and the due diligence process would also contribute to the
identification of potentially affected people as well as environmental risks and impacts.
A major part of the additional cost impacts of directors’ duties would be related to the
requirements to identify, assess and manage risks that the company faces in relation
to its stakeholders and sustainability matters. However, several factors underpin the
assumption that addressing sustainability risks would not result in significant cost
increases in addition to the (new) due diligence obligation and the public reporting
obligation under the CSRD. First of all, there is a potential overlap between stakeholder-
related (sustainability) risks to the company and the impacts of the company on its
stakeholders, and some form of due diligence is traditionally part of the company’s
overall risk management and damage prevention system. Also, companies under the
scope of the CSRD would already incur information gathering and data analysis costs as
they will be required to report to the public on their sustainability risks and impacts.
Many companies in the scope already have a risk management system and they may only
need to extend that. Furthermore, as part of the sustainability risks to the company derive
from a failure to prevent or mitigate adverse sustainability impacts, the recurrent cost
implications of managing sustainability risks to the company are to some extent covered
by operating due diligence processes. Accordingly, we will not calculate with additional
recurrent costs.
The one-off cost of setting up a risk management system is estimated to be around
EUR 5 000264
for a listed company and it can be assumed that it is less for SMEs (listed
or not). Similarly to the impact assessment of the CSRD, we can assume that around half
of companies already have risk assessment and management processes applying at least
to financial risks (such structures are already required by banks and investors) and we
can also assume, in line with the OECD due diligence study, that adding the additional
risk factors related to stakeholders and sustainability matters would not amount to
significant cost increases. Furthermore, compliance costs are expected to be company-
specific, largely depending on risks, and for companies that are frontrunners on
sustainability, the cost increases may be minimal, compared to other companies in high-
264
See draft Bill of the German Federal Government to strengthen financial market integrity, BT-
Drucksache 19/26966 of 24 February 2021, p. 62.
75
impact sectors. Because of these complexities, we can reasonably calculate with an
additional EUR 2 500 one-off costs on average for high-impact medium-sized
companies and listed SMEs, and with EUR 5 000 for large companies as, similarly to
the German impact assessment related to the draft Bill to strengthen financial market
integrity265
, we assume that only a fraction of companies would need to bear the
additional one-off cost of EUR 5 000.
Additional costs could be linked to increased litigation against board members, under
the respective national laws. However, the initiative does not aim at creating new actions
against directors. Thus, the shareholder general meeting and the (supervisory) board will
typically be empowered to initiate processes to hold directors to account under national
law. In addition, the initiative does not aim at affecting the “business judgement rule”
whereby the Courts refrain from substituting themselves for directors when it comes to
business decision, nor enlarging the conditions for bringing enforcement actions.
Therefore, it is likely that litigation cost increases will be negligible and, as a
consequence, that litigation risk will make companies less dynamic and more risk averse.
Integrating sustainability risks, impacts and opportunities, targets and actions into
the corporate strategy may result in administrative cost, which is however is difficult to
quantify. Likely changes to production processes, business models, etc. are difficult to
quantify for the reasons explained in Annex 4 and they would, to some extent, anyway
fall under the transition cost induced by the due diligence obligation. Nevertheless, the
specific cost of setting science-based targets as part of corporate strategy should be
considered as an additional cost of the directors’ duties in line with the scope of the
various policy options as this implies a fee – currently amounting to EUR 5 000266
– for
the external validation.
The following table summarises the incremental aggregated compliance costs of
directors’ duties per option:
Option 1
Option
2a
Option
2b
Option 3 Option 4
Number of companies incurring
additional cost of risk
management:
95 000 (in all options)
Aggregated additional compliance
cost of risk management duty:
€ 400 million (in all options)
265
Ibid.
266
This is the cost of the validation of two targets (e.g. one preliminary and one final) by the Science Based
Targets initiative (SBTi), which is a partnership between CDP, the United Nations Global Compact, World
Resources Institute (WRI) and the World Wide Fund for Nature (WWF). See SBTi’s website.
76
Option 1
Option
2a
Option
2b
Option 3 Option 4
Number of companies incurring
additional cost of science-based
target setting:
0 56 000 44 000 8 900 86 300
Aggregated additional compliance
cost of the science-based target
setting duty:
€0 €280 mn €220 mn €45 mn €432 mn
Total aggregated additional
compliance costs of directors'
duties:
€400 mn €680 mn €620 mn €445 mn €832 mn
Regarding other possible negative impacts on companies, some business respondents to
the Commission’s open public consultation considered that balancing the interests of
different stakeholders will make decision-making difficult, as it is hard to balance
possibly conflicting interests. Directors will have to manage the company in line with a
complex combination of interests from shareholders and diverse stakeholders. This risks
creating blurred lines of command and increase principal-agent problems. In this context,
it has to be stressed that balancing short and long-term interests, and potentially
conflicting interests has always been part of corporate decision-making. Furthermore,
evidence shows that all stakeholders’, including shareholders’ as well as their
beneficiaries’ (future pensioners, insurance policy holders, etc.) interests align to
preserve and promote the good long-term performance of the business. The general duty
therefore does not exacerbate principal-agent problems but creates an enabling
regulatory framework where all the factors that contribute to the long-term success
of the company can be properly taken into account and harnessed in directors’
decisions. It should also be underlined that directors’ duties do not go beyond the
interest of the company and they do not require the directors to make, for example,
environmental investments which are not in the (long-term) interest of the company
(even if such investments would provide a general benefit).
For the same reason, it is unlikely that companies in which directors balance the
interests of all stakeholders better, as well as the companies’ short- and long-term
interest, will have reduced access to capital. On the contrary, evidence listed in Annex
4 shows that more stakeholder-orientation is positively correlated with better access
to capital. This is even more likely as EU legislation is in the pipeline requiring banks
and insurance companies to properly manage environmental, social and corporate
governance risks at the level of their clients and as different investor types are already
today required to disclose information on ESG matters as regards their investments. This
has a potential to improve access to capital for companies that integrate stakeholder
interests better into their decisions.
As regards the argument that companies will become less innovative, evidence in the
problem definition as well as in Annex 4 shows that sustainable companies are among
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the most innovative ones today, and a long-term and sustainability focus is positively
correlated with innovation.267
Some respondents see a risk of new directors’ duties leading to director-dominated
companies. It is difficult to judge ex ante the extent to which such duties would reinforce
the role of directors in practice, and that also depends on the characteristics of the
specific company. At the same time, the purpose is to involve more stakeholders in
decision making, and therefore it is reasonable to argue that the general duty of
directors, together with more engagement with stakeholders, is likely to result in
corporate governance where all the interests relevant from the company’s
perspective are more properly channelled into decision making. Furthermore, the
global financial crisis of 2008-2009 revealed that as opposed to being very present,
shareholders (even long-term oriented pension funds and insurers) lack proper long-term
engagement with companies. It is therefore more likely that better involvement of other
stakeholders will prompt more interest from shareholders as well.
6.2.3. Benefits for companies
In terms of benefits, options 2 to 4 will result in directors of companies covered to pay
greater attention to sustainability aspects in allocating company’s resources. As the meta
studies in Annex 4 show, integrating sustainability aspects into corporate decisions is
directly correlated with operational cost reductions, resilience, more innovation, better
access to capital, better financial performance of businesses, which can materialize in the
short-run but is likely in particular in the medium to long run. Benefits could result from
costs avoided by early risks detection, better management of dependencies, more holistic
risk management, positive effects from investment (CAPEX, R&D, new technologies
and training), more trust and better engagement from stakeholders, including in the value
chains. As market pioneers in global markets, EU companies could make pre-emptive
investments in production capabilities by securing access to resources (e.g. suppliers,
skilled personnel, etc.), technology (e.g. through patenting), and gain economies of scale
vis-à-vis later market entrants. It would make companies also more resilient to adverse
consequences of changed environmental or social circumstances, or to sudden crises, as
in the COVID-19 pandemic. Moreover, such rules would secure a level playing field
across EU and also some degree of standardisation in directors’ responsibility for
sustainability, reducing discrepancies and providing companies with a common reference
and thus more legal certainty in that regard. Moreover, introducing harmonised EU rules
can also have benefits in making companies more interesting for sustainability-oriented
investors, public procurers, consumers, and various potential contractual parties, with
267
Evidence also shows that capital markets’ companies have been struggling to innovate in the last
decade due to persistent pressure to deliver on short-term earning commitments and reduced ability to
invest into innovation, see for example the Kay review referred to above.
78
positive consequences in terms of turnover increase. For more detail, please refer to
Annex 4.
In the public consultation all respondent groups, including businesses and business
associations considered that the benefits of sustainable corporate governance will
outweigh the costs. Respondent were also of the view that binding law with targets
would bring the highest benefits.
Which companies would benefit more from specific directors’ duties?
-The risk management duty would benefit in particular those companies which are
exposed, including through their value chain, to potentially high or disruptive
sustainability risks with significant impacts on et performance, see further in Annex 4.
- Companies already having developed risk management and impact mitigation processes
may have less costs but may also benefit less from the requirements.
- All companies may benefit from integrating stakeholder related risks and impacts into
the corporate strategy. It may lead to a necessary transformation of production processes,
business models. Smaller companies may also benefit, for example if they are part of a
value chain and they need to keep up with the transition efforts of the large buyer
company.
6.2.4. Environmental, social and fundamental rights impacts, and impacts on
the economy
Environmental and social impacts are expected to be positive, as explained above for due
diligence duties (Annex 4), with option 4 having the biggest positive impact.
The directors’ duties are expected to result in increased attention by the board to the
social and environmental risks and impacts associated with its operations, eventually
leading to adopting more sustainable and long-term oriented policies on employees (for
instance increased investments in policies and programmes aimed at workforce training,
reward and retention, human capital development) and for the environment (protection
and improvement of the natural capital of the company, investment into environment
friendly production processes, ceasing investments that result in adverse impacts on the
environment and thereby affect the long-term performance of the company). For
employees, the impact might be particularly positive in those EU countries where board-
level representation of workers is either absent or limited. Considering other
stakeholders, all options might contribute to an increased focus on the satisfaction of
consumers, with more sustainable and high-quality products for them. Importantly, also
stakeholders less able to influence the financial performance, but equally impacted by the
company’s activities, such as the local and global communities, would likely receive
higher attention.
Directors’ duties are not expected to have negative impacts either on the freedom to
conduct a business or to the right to property of the shareholders. Shareholders will not
lose any of their rights, i.e. those related to decision making, such as voting, approval
79
rights, or to the share of the profit, such as right to dividend. They preserve their power to
hold directors to account according to the rules of national and EU law. The so called
“business judgement rule” as referred to above will remain applicable.
As regards economic impacts, as directors’ duties focus to a large extent on preventing
risks which could affect the resilience and long-term viability of the company and
enabling directors to make long-term value–enhancing investments, including into
research and development, human capital development, new technologies, innovation,
CAPEX, sustainable production processes and resilient value chains, the macro-level
impacts of such actions and investment are likely to be positive. This may bring
competitiveness benefits in the mid to longer term. As explained in the problem
definition, at macro-level, in the long term, a trend of decrease in CAPEX and
investments in R&D as share of total revenues by companies might harm the level of
productivity and the innovative capacity of the economy as a whole.
Furthermore, better risk management, lower dependency on increasingly scarce natural
resources and resulting resilience, including to sustainability-related shocks (e.g. climate
change) is likely to have an overall stabilising impact on the entire economy and should
improve its resilience and shock-absorbing capacity.
6.2.5. Efficiency
In option 1 the general duty together with the risk management duty applying to a
sufficiently large scope of companies would be effective to contribute to a stronger focus
on holistic risk management and thereby to the achievement of the following specific
objectives:
- fostering the integration of sustainability risks (including from the value chain) into
corporate risk management,
- facilitating management of dependencies and ability to react to change.
The compliance cost of EUR 5 000 or 2 500 depending on the size of the company
should be assessed against to the benefits that better risks management brings for the
company, in particular if it is exposed to a wide range of sustainability risks and/or if
such risks are significant or disruptive. Furthermore, many large companies already have
risk management systems and may only need to extend that instead of setting up new
processes. This is also why the German law referred to above calculates with EUR 5000
for a listed company of any size, ranging from large to very large, independently of
turnover or other criteria.
The scope of companies falling under the risk management obligation would also be
aligned with the scope of the CSRD proposal, under which companies will be required to
report on environmental, social, human rights related, etc. risks. Given the expected
compliance burden coming already from the reporting regime, in particular as regards
risks identification and assessment, the additional cost implications are relatively low, but
the efficiency of the duty is considerably higher as directors will be required to manage
risks properly and could therefore be made accountable for not having carried out risk
80
analysis and proper risk management. Reporting will allow scrutiny of directors’ actions
and facilitate enforcement of the duty.
The duty would be slightly wider in scope than the CSRD. High impact medium-sized
LLCs would also be covered. This can be considered proportionate as medium
companies can also face significant risks and the cost implications are relatively low.
Furthermore, as banks will be required to manage sustainability risks linked to their
clients themselves, proper risk management for medium sized companies wanting to rely
on bank financing would become a necessity over time. Such requirement for medium
sized companies operating in high impact sectors therefore does not appear to be
disproportionate.
As regards the other specific duties, they would be included into a recommendation. The
efficiency of a recommendation is difficult to predict as it would depend on how many
Member States would decide to implement the recommendation. Proportionality is also
ensured by not imposing any specific administrative burden either on medium sized
companies or on small sized companies.
The main beneficiary of such positive impacts would be the company itself and all its
stakeholders. However, as explained in the problem definition, sustainability risk
management can have wide-ranging positive impacts beyond the company. For example,
directors managing transition risks arising from future devaluation of assets (for example
not investing into a coal fuelled plant) protects the long-term interest of the company as
such investments will result in considerable financial loss in the future, but has positive
consequences for the environment.
Better focus on stakeholder-related issues has the potential to build trust and loyalty from
stakeholders, including through the value chain. Investment into human and
environmental capital reinforces stability and resilience, but also dynamism, as
intellectual capital is the most important contributor to most company’s success and
stakeholder related capitals are the largest contributors to companies’ performance today.
Under option 2 and option 3, further to the general duty and the risk management duty
which were analysed above, a specific requirement for directors to implement due
diligence processes and measures, include sustainability risks and impacts in the
corporate strategy including science-based targets would apply.
Integrating sustainability risks and impacts, targets and actions into the corporate strategy
result in rather low administrative cost. The cost of the responsibility to implement due
diligence processes and measures has been calculated as part of due diligence costs.
These options, in addition to the benefits mentioned under option 1, will also ensure
more accountability related to impacts, elevating sustainability matters at the level of the
corporate strategy thereby fostering more sustainable business models, and hence
expectedly more efficient and thorough implementation of the general, risk management
and diligence duties as well. These benefits would materialize without imposing
significant additional compliance burden compared to the risk management and due
81
diligence duties. These options are therefore more cost efficient than option 1. Based on
the evidence demonstrating that reporting requirements were not sufficient in ensuring
wide uptake of sustainability risk and impact management (see under problem definition)
and therefore resulted in limited economic, social and environmental benefits, one can
assume that imposing duties on directors to take responsibility for such matters is likely
to result in significant benefits with relatively low compliance cost impact. Option 3 is
cost-efficient to deliver on the specific objectives as regards the corporate strategy as it
applies to a larger scope of companies (CSRD scope) and the duty to integrate
sustainability into the corporate strategy is highly cost efficient.
Option 2 and 3 both include a duty to include science based targets in the corporate
strategy. While the substantial climate mitigation obligation derives from the due
diligence obligation itself, the target is a tool for the directors to plan climate change
impact mitigation action, integrate those into the corporate strategy and measure progress
against the target. In option 3 the science based target setting as part of corporate strategy
applies only to very large companies. As the development and disclosure of the target
does not raise major costs, it can also be considered cost-efficient in terms of its potential
to help reap the benefits of the climate mitigation actions, including better access to
capital, more efficient production processes, better risk management with relatively low
cost.
As directors are responsible towards the company, the duty to implement due diligence
processes does not make the directors liable towards harmed people in case due diligence
is not carried out properly, but the directors can be made accountable by the general
meeting, minority shareholders or the board depending on national law if the necessary
processes are not set up or are not properly implemented.
As regards overall efficiency, the rating of option 2 and 3, is higher than that of option 1,
because these contain measures to elevate sustainability to a strategic level, align
sustainability objectives in corporate design, business plans and overall management,
which are likely to contribute to better implementation of risk management and better
cost efficiency across the company.
These additional measures help make directors even more accountable and will even
more increase the ability of companies to react to and potentially benefit from changing
environment while having positive social and environmental impact.
In option 4 all specific options apply to the widest scope of companies (CSRD). In terms
of its efficiency, one could argue that the more companies are in the scope of the duties,
the less benefit an individual company derives from its sustainability performance. As
explained in Annex 4, this is likely for competitiveness benefits such as reputational
benefits or benefits arising from attracting talent, but certain benefits are not likely to
reduce because more companies are covered by the scope of the obligation (such as for
example benefits arising from more cost efficient production processes, better risk
management, more motivated staff because of investment into training and human
capital, better yield due to protecting natural capital). Yet, similarly to the due diligence
obligation, one could argue that extending the specific obligations and therefore the cost
82
burden to a very wide range of companies, which, however may have less sustainability
related risks and impacts would not result in an equal or increasing level of overall
benefits, including social and environmental benefits, so the efficiency rating of this
option should be lower than that of Option 2 and 3.
Options Efficiency
Option 1 +
Option 2 +++
Option 3 +++
Option 4 ++/+++
6.2.6. Stakeholders’ views268
78.2% of respondents to the open public consultation269
agreed270
that companies and
their directors need to take account of stakeholder interests271
in corporate decisions.
272
Recent calls for action of prominent CEOs as well as leading scholars and experts on
company law273
support this view as did survey respondents274
of the Supporting study
on directors’ duties275
.
While 70% of overall respondents believe corporate directors should be required by law
to a) identify the company’s stakeholders and their interests, b) manage the risks for the
company in relation to stakeholders and their interests and c) identify opportunities
arising from promoting stakeholders’ interests, individual companies expressed slight
268
For more detailed information on the results of the open public consultation, please refer to Annex 2.
269
Summary of the open public consultation on the sustainable corporate governance initiative
270
NGOs supported the need for a holistic approach with 93.2%, companies with 60% and business
associations with 58.6% of respondents expressing an opinion. Some of the 22.500 campaign respondents
and petition signatories strongly agreed on the need for action on all elements of directors’ duties. A small
group of respondents indicated that these interests should only be considered to the extent that these issues
are relevant for the financial performance of the company (18.5% of those expressing an opinion).
271
When asked about the interests that are relevant for the long-term success and resilience of a company,
respondents highlighted the interests of employees, customers, likely consequences of long term decisions,
persons and communities affected by operations of the company, local and global natural environment
(including climate), employees in the company’s supply chain, society and shareholders are important.
272
This result is in line with the results of the survey in the Supporting study on directors’ duties, where
91% of respondents agreed with the statement that the company’s interest should encompass the interest of
stakeholders and the environment other than the interests of shareholders.
273
Call to Action on Sustainable Corporate Governance:
https://corpgov.law.harvard.edu/2021/03/09/call-to-action-on-sustainable-corporate-governance/.
274
91% of respondents agreed with the statement that the company’s interest should encompass the interest
of stakeholders and the environment other than the interests of shareholders.
275
Feedback to the inception impact assessment (roadmap) to this initiative, various position papers to the
open public consultation for this initiative as well as employers’ organisations within the social partners’
dialogue highlighted concern about the methodology applied in the supporting Study on directors’ duties
and the need for legislative intervention on directors’ duties as such as it might put into question the
fundamentals of freedom of enterprise and property/ownership. In particular obstacles identified were
mostly linked to diverging interests of stakeholders. They and cautioned about the possible negative effects
on dynamism and innovation, which require the avoidance of lock-in effects, investors’ willingness to
invest which could result in reduction of foreign investment and thus a loss of competitiveness. In turn,
according to this line of reasoning, uncertainty and a reduction in the shareholder surplus could negatively
affect funding for the development of environmentally friendly technologies.
83
support, and business associations disagreement.276
Similarly, as regards a legal
requirement that corporate directors should set up adequate procedures and measurable
(science-based) targets, while 70% of overall respondents expressed agreement,
individual companies were acquiescent, and business associations expressed
disagreement.277
Regarding the need to clarify in legislation as part of directors’ duty of care that
corporate directors should balance the interests of all stakeholders, instead of focusing on
the short-term financial interests of shareholders, 68% of overall respondents expressed
support, with businesses and business associations expressing some disagreement278
.
86% of overall respondents, including businesses and business associations, supported
the need to integrate sustainability risks, impacts and opportunities into a company’s
strategy, decisions and oversight within the company.279
In terms of expected impacts, respondents believe that binding law with targets would
have the most impact on administrative, litigation and other costs, but would also bring
the highest benefits (performance, competitiveness, risk management and resilience,
innovation and productivity, environmental and social performance).280
6.2.7. Coherence
All options would be coherent with other main EU policy objectives and initiatives.
Option 4 presents the best technical coherence with the CSRD proposal as their scope
and content are largely aligned and option 2 and 3 are also largely coherent with the
CSRD in terms of their content.
All four options would strengthen directors' duties related to sustainability by making
explicit that acting in the best interest of the company entails taking into account the
interest of the shareholders with other interests, including the likely (social and
276
Individual businesses expressed slight support (a: 54.3%, b: 59.2%, c: 46.8%) while business
associations expressed disagreement (a: 64.6%, b: 65.6%, c: 69.9%). NGOs, on the other hand, mostly
agreed (a: 93.7%, b: 91.8%, c: 83.7%). Member States respondents mostly agreed, with 10 responses (from
Belgium, Czechia, France, Germany, Luxembourg and Spain) expressing support and one respondent from
France and one from Spain disagreeing to some extent.
277
Individual companies were acquiescent (49.4% expressing support) while business associations mostly
expressed disagreement (73.9%). 93.1% of NGOs expressed support. As regards Member State responses,
8 responses (from Belgium, Czechia, France, Germany, Italy, Luxembourg and Spain) agreed. One
respondent from France, one from Spain and one from Italy disagreed to some extent.
278
While 92.4% of NGOs expressed agreement, individual companies expressed disagreement with 53,9%
and business associations did so with 77.5%. As regards Member States, 7 respondents (from Belgium,
Germany and Spain) agree and 5 disagree (from Finland, France, Italy, Luxembourg and Spain). Within the
framework of social partner’s dialogue, trade unions considered that clear and broad definition of directors’
duties and the company’s interest should be defined in EU law.
279
Individual companies and business associations expressed support (70,6%). In the case of NGO
respondents, 92.4% agreed. As regards Member State respondents, 11 respondents agree (Belgium, France,
Germany, Italy, Luxembourg and Spain), while 1 respondent from France disagrees.
84
economic) consequences of decisions in the longer term (beyond 3-5 years). Largest
scope Option 4 would certainly contribute best to the goals of the European Green Deal.
All four options would also complement, on the corporate side, the clarification of
fiduciary duties of investors under EU Regulation on disclosures relating to sustainable
investment and sustainability risks, which promotes a better disclosure on the integration
of ESG factors into investment decisions and advice by financial market participants.
They are also largely coherent with the sustainability risk management duty in the
pipeline for the banking sector.
Options Coherence
Option 1 +++
Option 2 +++/++++
Option 3 +++/++++
Option 4 ++++
6.2.8. Proportionality
As the duty to act in the interest of the company applies to all LLCs in national law, any
narrower option in terms of scope (e.g. exclusion of SMEs) would not be easily
implementable and legally sound. This duty is general and therefore does not impose any
immediate and specific administrative cost linked to its implementation on SMEs. Cost
and administrative burden would thus be limited for the vast majority of SMEs whilst
still involving all LLCs in the shift towards a sustainable corporate governance.
Proportionality was also considered for specific duties. Depending on the option, the
specific duties are contained either in a recommendation or apply with phase-in and only
to high impact medium companies and or listed SMEs. For further detail, see under
efficiency.
6.3. Directors’ remuneration
6.3.1. Effectiveness
The option considered on directors’ remuneration (general clause to ensure that the
variable component of remuneration schemes facilitates or at least does not hinder
compliance with the newly introduced due diligence and directors’ duties) could
contribute to this initiative’s specific objective of improving corporate governance
practices to facilitate the integration of sustainability into directors’ and company
decision-making.
The considered general provision could be complementary to the other measures on due
diligence and directors’ duties as considered in this impact assessment and would thus
aim at ensuring that the integration of sustainability considerations as fostered by the
other measures within this initiative is ideally incentivised and in any case not
contradicted by the structure of the remuneration policy.
85
While it could be expected that the manner in which companies (falling within the scope
of the Shareholders’ Rights Directive, i.e. listed ones) implement its existing provisions
relating to the remuneration policy, would have to be adapted to the new rules on due
diligence and directors’ duties, a general clause would stipulate clearly (for all companies
falling under this initiative) that such adaptation should take place. As such, the due
diligence and directors duties with their clear content would be a benchmark which
would need to be considered when determining variable remuneration. The existing
provision of the SHRD does not link the expectation of the remuneration policy
contributing to sustainability to any concrete benchmark. A general provision would
provide further guidance whilst leaving flexibility for implementation. It would, for
instance, allow companies to choose which environmental and social indicators to link to
variable remuneration and how exactly to establish this link. At the same time, such
margin of discretion would need to be exercised with the overall objective of facilitating
or at least not hindering compliance with due diligence and directors. This would exclude
devising unsuitable or conflicting remuneration policies. As explained above, more
prescriptive or specific measures, have not been considered pending further experiences
with the application of the Shareholders’ Rights Directive. Also, the offered flexibility
would allow companies to find solutions taking account of their needs and specific
circumstances on a case by case basis. On the other hand, in light of the greater clarity on
directors’ duties that would be offered by the proposal, for all types of limited company
within scope of those obligations, it could be considered that such a complementary
general provision on remuneration might have quite marginal effects – or at least,
additional effects whose reach is difficult to anticipate - in securing compliance with such
explicit obligations, which would in any case be enforceable by both public authorities
and shareholders.
6.3.2. Costs
Companies would need to revise their remuneration policies and bear the related
adjustment costs. These costs should be very small: listed companies already are required
to have and disclose the remuneration policy and the remuneration report according to
the Shareholder Rights Directive, any disclosure costs281
are not linked to the new
measure. Other companies neither have to publish their remuneration policy nor to report
on this, so would not incur any costs in this regard.
6.3.3. Benefits for companies, efficiency
This complementary remuneration measure would strengthen the benefits that will be
achieved by the newly introduced directors’ duties, as explained above. While companies
currently make limited use of the possibilities to set their remuneration schemes to
281
See the Impact Assessment of the proposal for the Shareholder Rights Directive II (https://eur-
lex.europa.eu/legal-content/EN/TXT/?uri=SWD:2014:0127:FIN).
86
correspond to sustainability objectives282,
and indirect effects of any newly introduced
duties on remuneration schemes could be expected, the considered general clause would
give a push to ensure that remuneration policies do not produce contradictory incentives
but rather create a catalyst for compliance with the newly introduced duties. To the extent
that a complementary remuneration measure would foster companies’ adaptation of
remuneration policies (for all companies falling under this initiative, i.e. beyond the
scope of the Shareholders’ Rights Directive), it could be expected to reinforce positive
effects for businesses. It also strengthens the strategic view of directors on sustainability
matters in line with the directors’ duties with their potential to enhance positive impact
(innovation, operational efficiency, etc.) At the same time, for the same reason as in
section 6.3.1, it is difficult to ascertain objectively whether such a measure would have
more than marginal additional effects in securing for businesses themselves the benefits
flowing from the newly clarified or defined directors’ duties.
6.3.4. Environmental, social and fundamental rights impacts, and impacts to
the economy
A complementary measure on directors’ remuneration is expected to lead directors to
become more focused on sustainability aspects and foster long-term-oriented business
decisions, in line with the other measures taken under this initiative. In this sense, the
measure should strengthen the positive impacts on the company and ultimately on the
economy as well as on stakeholders.
There is no expected negative impact for the right to property of directors as
shareholders, neither to the freedom to conduct a business.
6.3.5. Coherence
The considered option would be coherent with the existing disclosure rules introduced
(for listed companies) by the Shareholder Rights Directive II. It would not interfere with
the application of that disclosure regime which could be evaluated as such in due time.
6.3.6. Stakeholders’ views283
Stakeholders’ views on remuneration topics are diverse: respondents to the open public
consultation in favour of further regulating directors’ remuneration favoured options
including restricting the use of shares for 4 or 5 years, or limiting or banning the payment
of executives with shares or share options altogether. Those disagreeing with restrictions
to pay directors with shares believe that share-based remuneration is the best way to
increase long-term orientation of management. 284
282
See in problem description.
283
For more detailed information on the results of the stakeholder consultation, please refer to Annex 2.
284
When it comes to ranking options, among the limited answers received - overall, approximately half of
the respondents did not answer the question, among individual companies and business associations only
one in three provided an answer - respondents scored highest among the proposed options the followings:
87
A group of respondents expressed disagreement with further regulating remuneration as
they consider that the current European hard law framework contains sufficient
provisions regarding remuneration structures, such as the Shareholder Rights Directive
II, or the banking rules. Some respondents plead to leave management remuneration up
to the company as they find it the most qualified to determine how executive
remuneration aligns best with its business model, strategy, and long-term goals.
6.3.7. Proportionality
The considered measure would respect the principle of proportionality as it would not go
beyond what is necessary to address the identified drivers (i.e. that directors’
remuneration incentivises improving short-term share price performance and short term
financial value maximisation) and contribute to the specific objectives of the initiative.
It would create new obligations for companies under the scope as regards adapting their
remuneration schemes, but with very limited costs, and leaving to companies the
possibility to choose how to adapt to this requirement to their business model and
sectorial specificities.
This would go in the direction of a more proportionate intervention for businesses, at
least relative to other, more far-reaching possible interventions, since they expressed
strong concerns, as evidenced in their feedback to the options proposed in the public
consultation, as regards interventions in remuneration policies at this stage and flagging
the risks of too prescriptive rule. This being said, due to the difficulty in anticipating,
even qualitatively, the additionality in practice of such a general remuneration provision
relative to the other provisions envisaged in respect of directors’ duties, the assessment of
necessity – an inherent part of the proportionality assessment – is finely balanced.
7. HOW DO THE OPTIONS COMPARE?
Options285 Effectiveness Efficiency Coherence
Corporate due diligence options:
option 1 + + ++
option 2 ++ ++ ++++
option 3
+++ (option 3a)
+++ (option 3b)
+++ ++++
option 4 +++ ++/+++ ++++
making compulsory the inclusion of sustainability metrics linked, for example, to the company’s
sustainability targets or performance in the variable remuneration (average score of 5.3 on a 7-point scale),
taking into account workforce remuneration and related policies (average score of 5.2 on a 7-point scale)
and the requirement to include carbon emission reductions, where applicable, in the lists of sustainability
factors affecting directors’ variable remuneration (average score of 4.8 on a 7-point scale).
285
The remuneration measure has not been considered in this table, as explained under 6.3., it would
complement the measures on due diligence and directors’ duties considered in the package.
88
Options285 Effectiveness Efficiency Coherence
Directors’ duties options:
option 1 + + +++
option 2 +++ +++ +++ / ++++
option 3 +++ +++ +++ / ++++
option 4 +++ ++/+++ ++++
8. PREFERRED OPTION
Based on the above analysis, the preferred option and direction to take is the combination
of the following elements:
- option 3a or 3b from among the due diligence options,
- option 3 from the directors’ duties options, and
- possibly complemented by the described measure on remuneration.
8.1. Combined impact preferred option
For the reasons explained above, the combination of these options is best suited to
achieve the objectives of this initiative. This combination is therefore recommended for
political endorsement. Due diligence and directors’ duties are key pillars for achieving
the objectives of the initiative. They are also closely interrelated. Clarity on directors’
duties and fostering long-term oriented business decision are key for due diligence to
deploy its full potential. Clear rules on risk an impact management and a strategic focus
on sustainability are most efficient to foster change and necessary investments for the
transition.
Despite good practice of many frontrunner companies, market failures affect the entire
market and slow down the spread of good governance. Given the urgency of tackling
sustainability challenges, legislative intervention is necessary and likely to have
significant positive impact, in particular in the mid to longer term on the economy.
Compliance costs have been reduced to the maximum.
Complementing mandatory due diligence and directors’ duties with the considered
measure as regards variable remuneration could contribute to enable corporate directors
to focus on long-term sustainable value however, the fine balance of impact
considerations allows this to be left to political appreciation.’
The costs and benefits of the preferred options are summarised in Annex 3.
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9. HOW WILL ACTUAL IMPACTS BE MONITORED AND EVALUATED?
To monitor progress towards meeting the specific – and ultimately the general –
objectives, the Commission would rely on the reports of various stakeholders, including
in particular industry associations, industry initiatives, consultancy firms, environmental
and human right defender civil society organisations, international organisations (e.g.
OECD, UN) and public authorities that continuously or periodically monitor
developments in corporate governance and companies’ sustainability performance.
The Commission will consider how to best draw on surveys and studies to specifically
focus on some of the indicators that were used to demonstrate the existing problem and
its drivers. Our own studies and stakeholders’ reports and surveys could, for instance,
include:
– surveys among corporate leaders which show how time-horizons in strategic
decision making will have evolved and been extended to take into account
broader stakeholder interests and which assess if directors’ perceptions on short-
term pressures and motivations will have changed;
– reports and case studies on human rights abuses and environmental harm linked
to EU companies;
– ranking of Member States’ environmental, social and human rights spill-over
impact on other countries’ abilities to achieve the SDGs;
– assessments and estimations on EU companies’ (and their value chains’)
contribution to overall environmental footprints, e.g. GHG emissions, pollution
etc. and on possible changing trends;
– reports and case studies on reorganisation of supply and value chains, changing
production processes, business practices and business models, changing product
features, possibly covering high-risk sectors, products, materials, issues or
specific impacts;
– analysis of possible changes in directors’ pay structures and links with the
evolution of corporate (long-term) R&D spending, CAPEX investments, short-
term profit or share price, and the companies’ performance in the various
sustainability areas or its performance (viability or survival) in the longer run;
– comparative analysis of the development of directors’ remuneration versus non-
executive and employee wages to see the impact on income inequality.
It could also be considered to engage with competent national authorities to gather part of
the required data to measure progress and to also assess progress towards the general
objectives to the extent possible. It should be noted that monitoring progress towards
meeting the general objectives as such is very complex, since it would be
methodologically challenging to distinguish between the impacts of the proposed
initiative and other possible causes.
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An evaluation of the package of preferred policy options should be carried out in line
with the evaluation criteria under the Better Regulation Guidelines to allow an evidence-
based judgement of the extent to which the intervention is effective, efficient, relevant
given the current needs, coherent both internally and with other EU interventions and
has achieved added value. An evaluation would be carried out by the Commission on the
basis of the information gathered during the monitoring exercise and additional input
collected from the relevant stakeholders, as necessary. An evaluation report could be
issued 5 years after the end of the transposition period, taking into account the time
needed for application and data collection.