Emerging sustainability obligations in the EU and their impact on Swiss (and international) business.

On 23 February 2022 the European Commission published its long-awaited proposal for a Directive on Corporate Sustainability Due Diligence (henceforth “Directive”). While several Committees of the European Parliament (EP) have already released draft opinions, the Member States are still trying to find a common negotiating position. It may therefore not be until the end of next year (2024) that we see the final version of the law. But the general level of expectation towards companies is already clear today.

According to the draft EU Directive, companies above a certain size are expected to take appropriate steps to implement due diligence measures to prevent or minimise adverse impacts on human rights and the environment. The obligation would apply with respect to their own operations, the operations of their subsidiaries, and the value chain operations carried out by entities with which the company has an established business relationship. Established business relationships are defined as lasting relationships which do not represent a negligible or merely ancillary part of the value chain.

The Directive would apply across all sectors and covers a broad range of human rights and environmental conventions (see the Annex of the Directive).

Interestingly, the draft Directive also requires the companies concerned to adopt a plan to ensure that their business model and strategy are compatible with limiting global warming to 1.5 °C, in line with the Paris agreement.

In recent years a number of European countries have adopted or announced mandatory human rights due diligence (HRDD) legislation on a national level.

In 2017, France was among the first to pass the “Duty of Vigilance” law which has cross-sectoral coverage in large companies operating in France. The law obliges the affected companies to exercise due diligence along their supply chain for a broad range of rights, from human rights and fundamental freedoms to serious bodily injury or environmental damage and health risks.

Last year, Germany and Norway followed suit and passed similarly comprehensive laws (the German Supply Chain Act and the Norwegian Transparency Act).

In December last year the Netherlands announced that it was developing its own national corporate due diligence legislation following repeated delays in releasing the EU Commission’s draft.

Finally, Spain has launched a draft bill on human rights protection, sustainability, and due diligence in transnational business activities.

Like Switzerland, several countries have also adopted narrower forms of HRDD regulations. These are specific to some of the most severe human rights violations, such as modern slavery and child labour, or apply to companies in high-risk sectors only. Examples include the Modern Slavery Act in the UK or the EU Conflict Mineral Regulation.

There are two ways in which Swiss companies may be affected by the draft EU Directive in its current version and similar HRDD laws in Europe:

1. Direct obligations: Foreign companies may fall directly under the scope of the law through their territorial connection with the jurisdiction by having significant operations there.
2. Indirect obligations: Obligations may be passed on to foreign suppliers by their customers who are in scope of the law.

Direct obligations
According to estimates by the EU Commission, around 13,000 EU and 4,000 non-EU companies would be affected by the regulation.

Unlike for locally established companies, the draft EU Directive does not set an employee threshold for third-country companies to fall under the scope the law. Instead, a turnover criterion is used. According to this criterion, the Directive should apply to third-country companies if either one of the two conditions are met:

• a) they generated a net turnover of more than EUR 150M in the EU in the financial year preceding the last financial year,
• b) they generated a net turnover of more than EUR 40M in the EU in the financial year preceding the last financial year, provided that at least 50% of its net worldwide turnover was generated in one or more of the sectors defined as high-impact sectors.

The definition of high-impact sectors comprises agriculture, the textile industry, as well as the extractive industries, including the manufacturing and wholesale trade of related goods (see Art. 2 para 1 (b) for more detailed description).

The methods for calculating net turnover for non-EU companies in the EU are laid down in Directive (EU) 2013/34 as amended by Directive (EU) 2021/2101.

The German Supply Chain Act will apply to foreign companies as of January 1, 2023 if they have a branch in Germany and employ at least 3,000 employees in Germany. The employee threshold will be lowered to 1,000 employees as of January 1, 2024. Unlike the EU Directive, the Supply Chain Act calculates the threshold with the number of employees and not with full time equivalents (FTEs).

Indirect obligations

The draft EU Directive requires companies in the scope of the law to obtain contractual assurances from their direct business partners. These assurances are intended to commit business partners to complying with the company's code of conduct and preventive measures and, if it comes to that, its corrective action plan.

The same is expected from companies that fall under the German Supply Chain Act regarding their direct suppliers. If those suppliers wish to do business with a company affected by the law, they must contractually commit to complying with the human rights related and environmental expectations of the company and to ensuring implementation along their supply chain.

The contractual assurances must be accompanied by appropriate control mechanisms to verify compliance with companies’ expectations. This may, among other things, include third-party verification/audits, trainings, or implementation support for SMEs.

The companies in scope of the laws are asked to communicate precise expectations vis-à-vis their business partners. In doing so, it is reasonable to assume that the companies will closely follow the obligations and mechanisms formulated in the respective law. This may ultimately make the provisions of the law relevant to companies that are not direct addressees of the law.

In short, all non-EU companies maintaining downstream business relationships into the EU would be affected.

The individual HRDD laws differ in several aspects: e.g., liabilities and penalties, material scope, personal scope, how far along the supply chain the responsibility of the companies extend, and which business relationships need to be considered etc.

However, all regulations stipulate an HRDD obligation, and the required elements of this HRDD are comparable across the legislations. They are based on international standards like the UN Guiding Principles on Business and Human Rights and the OECD Guidance on Responsible Business Conduct, and specific sectoral OECD guidelines.

Due diligence describes a risk-based and dynamic process with clear responsibilities and objectives that identifies, assesses, prevents, and mitigates potentially adverse impacts on an ongoing basis – considering companies’ own operations, supply chain and other business relationships.

The general due diligence framework of the OECD can be summarised in the following six elements:

1.  Embed due diligence into policies and the management system; including sustainability mission statement
2. Identify actual or potential adverse impacts. Implement complaint mechanism
3. Cease, prevent or mitigate potential or actual adverse impacts; implement controls
4.  Monitor the implementation and effectiveness of the due diligence policies and measures
5. Document and communicate relevant information on the due diligence programme and how actual or potential adverse impacts are addressed
6. Provide for or cooperate in the remediation of adverse impacts.
   

With a comprehensive and industry-specific application of the due diligence framework and guidelines by the UN and the OECD, companies can meet their direct and indirect responsibilities under the different laws.

Next to the mandatory HRDD regulations, other regulations in the field of sustainability require companies to exercise due diligence based on similar elements to the ones outlined above.

One example is the EU Commission’s proposal for a regulation on deforestation-free products which will enter into force after its formal adoption by the European Parliament and the Council. The regulation foresees that relevant commodities – cattle, cocoa, coffee, palm oil, soy and wood – and derived products may only be placed or made available in the EU or exported from the EU if certain criteria are cumulatively met. One of the criteria is that the commodities and products are covered by a due diligence statement.

Another example is the EU Commission’s proposal for a regulation on prohibiting products made with forced labour in the EU market from September 2022. In its current version the proposal covers all products, including those made in the EU for both domestic consumption and exports, and imported goods, without targeting specific companies or industries. In case there are substantiated concerns about forced labour in an economic operator’s value chain, the proposal would enable the designated competent authorities to order an import ban for the resulting products at the EU border, and national governments could withdraw products made with forced labour from EU markets. In an assessment preceding the ban, economic operators would be able to prove that the concerns are not substantiated by means of solid forced labour due diligence.

Authors: Philipp Weber-Lortsch and Gina Rüegg