Supporting the European Green Deal[i] in aide of carbon neutrality and as part of the European Commission’s Action Plan on Financing Sustainable Growth,[ii] the Study on Due Diligence Requirements Through the Supply Chain,[iii] published 24 February, calls on regulatory reform to standardize approaches to risk management that measure, monitor and manage supply chain impacts.
Most businesses surveyed stated that they did not systematically address environmental or social impacts in their operations or supply chains, and if they did, most approaches were bound within operational silos. Most stakeholders surveyed concurred. Voluntary certification measures have changed single businesses’ operations yet have not produced a sector lift as not all businesses are playing by the same rules.
Most wanted a harmonized multi-sector EU law enabling legal certainty within a non-negotiable standard applicable to all. In this manner, regulation would simplify at times countervailing and competing voluntary approaches, ensuring appropriate risk management tools to measure supply chain impacts that would simplify procurement functions within an increasingly complex supply chain landscape.
Due diligence matters because its means that companies can be certain that, both in their operations and the suppliers they purchase from, materials and processes “do no harm”. The EU is the largest single market globally. It has a responsibility not to harm others and to conserve the environment while, at the same time, mitigating economic risk and protecting capital.
After a rigorous engagement with, and survey of, private sector best practices, the paper presents four options for the EU to standardize risk management of due diligence in EU companies’ own operations and through their supply chains for environment and human rights impacts.
Concurrently, the EU last week published ‘The State of Corporate Sustainability Reporting in the EU’, which showed that only one in five companies disclose their approaches to due diligence, making comparability within industry and across the private sector challenging.
The Study on Due Diligence Requirements Through the Supply Chain can be summarized in the following way:
Market Practices
This portion of the study assessed current due diligence practices in companies’ operations and their suppliers. While the most frequent risk management tools used in procurement were contractual clauses, codes of conduct and audits, businesses stated that the panoply of legal and voluntary schemes created a dizzying array of options creating an inefficient response to due diligence reputational risks, investors’ requirements and consumers’ preferences.
Most institutions surveyed supported a mandatory set of due diligence tools, an evolution from today’s tick-the-box exercise, as a legal standard of care to ensure harmonization and standardization, such that those that positively comply would be rewarded for their actions, while those reluctant to participate would be penalized for their inaction.
Regulatory Review
The study assessed various regulatory frameworks globally that might support solving the problem of operational and supply chain environmental and social impacts. While many different national and regional voluntary schemes and regulatory frameworks do exist, this hodgepodge of frameworks are often sector-based or issue-specific.
The 2014 Disclosure of Non-Financial and Diversity Information, the 2017 Guidelines on Non-Financial Reporting and its 2019 Supplement on Reporting Climate-Related Information all require categories of non-financial environmental, social and governance (ESG) data to be disclosed by institutions.[iv]
But, while there are many regional laws in place in the EU, there is currently no overall legal requirement for EU companies to conduct due diligence on their environmental and human rights impacts.
A key option raised in the study is whether the EU could mandate the application of the UN Guiding Principles on Business and Human Rights and the OECD Guidelines for Multinational Enterprises, making both legally binding.
Scenarios and Benefits
As we know, nothing in life is free, so let’s discuss the costs and benefits of each option. The report suggests there are four scenarios going forward.
- Option 1: Business-as-usual with no policy changes. In this option, business-as-usual continues with national level initiatives often not aligned across risks, sectors, or countries in the EU. Monitoring costs increase as diverging approaches develop, also increasing the costs of co-ordination. Environmental and social impacts are the same as currently.
- Option 2: New voluntary guidelines/guidance. Costs would increase as new standards are developed. This scenario assumes market integration is easy, yet based on previous experiences with existing standards, the environmental and social impacts are forecast to be the same or similar as Option 1: Business-as-usual.
Option 3: New regulation requiring due diligence reporting. In this scenario, forecast industry implementation costs might be higher at about EUR 3.5 billion annually across all EU27. The downside to Option 3 is that it does not address legal duty of care. Legal duty of care requires companies to be liable for the impacts from their operations and their supply chain purchases – just as a car driver is liable for an unfortunate accident they cause.
Yet Option 3 might have some positive impacts on human rights (labour rights, working conditions, rights holders) and environmental issues (depending on the environmental reporting, monitoring and enforcement requirements).
- Option 4: New regulation requiring mandatory due diligence as a legal duty of care. New regulation requiring due diligence reporting at Option 3’s baseline but with some additional costs. Key to Option 4 is that this would require some legal changes by EU27 countries regarding the definition and use of the phrase “duty of care” and by extension, extended producer liability. For example, while duty of care is defined under UK tort law such that a company may be liable in negligence if the company breaches a duty to a claimant causing the claimant to suffer, in other countries in the EU, duty of care refers to whether an individual director owes a company.
Standardized legal “duty of care” throughout the EU27 would harmonize (extended) producer responsibility and make companies fully responsible for the impacts from their operations and their supply chain procurement decisions. At the same time, this would enable business and retail customers to make better purchase decisions based on actual environmental and social impacts of the goods and services they are purchasing. Environmental and social benefits would be highest under Option 4, so companies who exceeded standardised environmental and human rights risk management approaches would certainly see a reputation uplift and possible increase in share prices for doing the right thing.
Only by choosing to enable companies in unison, via simplified regulatory regimes, to measure, monitor and manage their environmental and social impacts, can the EU achieve its goal to be the first climate neutral continent in a manner that creates a level playing field and encourages private sector innovation.
The EU can choose to lead globally by implementing standards strengthened by legal duty of care to ensure manufacturers’ responsibility, which, at the same time, empower rigorous and standardized conservative approaches to supply chain risk management. In this way, procurement officers in corporations can know exactly what they are purchasing, from where and how it was produced. The EU can choose to uplift its economy to a simplified regulatory model that provides a level playing field for all businesses, while moving the EU one step closer towards becoming climate neutral.
[i] European Commission. A European Green Deal: Striving to be the first climate-neutral continent. n
[ii] European Commission (8 March 2018). Sustainable finance: Commission’s Action Plan for a greener and cleaner economy.
[iii] Smit et al., EU Commission, Directorate General for Justice and Consumers (January 2020). Study on due diligence requirements through the supply chain: Final Report.
[iv] Climate Standards Disclosure Board and CDP (February 2020). EU Environmental Reporting Handbook: What does environmental reporting look like in line with the EU Non-Financial Reporting Directive?
