What do companies need to know about Sustainable Corporate Governance and directors’ duties in the EU?
Directors need to act now to integrate sustainability into the company’s strategy, decisions and oversight. In the current climate, there is a growing demand from investors and other stakeholders on companies to take into account the impact of their business operations on the environment, society, human aspects and the economy. They want the board to actively engage in integrating sustainability into its long-term strategy.
Promoting sustainability is also a high priority of the EU. To this end, the EU is currently preparing a proposal for a European Directive on Sustainable Corporate Governance. This initiative aims to introduce new rules on incorporating sustainability in long-term business strategies. It should steer companies towards more long-term visions that incorporate sustainability, which includes their environmental, human and social rights impact.
The initiative is complementary to the proposal for a Corporate Sustainability Reporting Directive, which amends the existing reporting requirements on sustainability matters.
The initiative on Sustainable Corporate Governance seeks to push companies to focus more on long-term sustainable value creation instead of short-term value creation and better manage sustainability-related matters. We expect the proposal for a European Directive on Sustainable Corporate Governance to be published later this year. As the proposal may lead to far-reaching legal reforms for all companies doing business within the EU, this article will take a look at some of the new expected rules.
Directors’ duty of care and liability
The European Commission is exploring the possibility of clarifying and expanding the directors’ duties of care. The scope of the duty of care is not always clearly defined in all Member States. According to the European Commission, this lack of clarity leads to a short-term focus on financial interests of shareholders. This would form a key obstacle to achieving Sustainable Corporate Governance.
The European Commission may introduce a duty of care that require directors to consider the environmental, human rights and social impacts of their activities. Directors may also need to integrate sustainability risks, impacts and opportunities into their company’s strategy and decision-making. Adequate procedures and measurable targets may become mandatory to ensure stakeholder risk and impact are identified, prevented and addressed. For example companies may be required to limit their own environmental footprint, or to actively trace the conditions under which production processes further up the supply chain take place.
These procedures and targets could force directors to take a broader group of stakeholder interests such as environmental issues into account. These interests may even prevail in case of conflicts with a company’s commercial interests. The primarily focus of the director on the interests and wellbeing of the company itself might be forced to shift towards other interests. The European Commission is looking at a broad range of stakeholders such as employees, environmental organizations, or any individuals or groups impacted by operations of the company or its supply chain.
Directors may face new, significant liability risks if their duty of care is extended in favour of this broader group of stakeholders. The European Commission is examining whether it needs to strengthen enforcement mechanisms outside of internal board structures and general meetings of shareholders. This might include an enforcement role for stakeholder groups, such as those representing environmental concerns.
In anticipation of the proposal, companies and its directors should check their internal procedures and targets. They should also check whether they already include all stakeholders in their corporate strategy and decision-making.
Due diligence duty – human rights and the environment
The European Parliament supports the European Commissions’ Sustainable Corporate Governance initiative. The European Parliament adopted a legislative initiative report, including a draft directive, setting out recommendations to the European Commission. The report introduces a new mandatory corporate due diligence duty.
The European Commission is now exploring this corporate due diligence duty requiring companies to establish and implement adequate processes for preventing, mitigating, and accounting for human rights, health, and environmental impacts in companies’ operations and supply chains.
The European Commission is also considering if a mandatory corporate due diligence duty should be accompanied by an enforcement mechanism.
Companies should check whether they already have policies in place and processes to take into account human rights and environmental due diligence in its business and supply chains.
Changes to directors’ remuneration
The European Commission may also introduce appropriate enforcement measures accompanying the (extended) duty of directors. Different approaches are for instance being considered to ensure directors’ remunerations are aligned with longer-term perspectives, such as non-financial performance.
The European Commission is investigating the integration of sustainability risks and opportunities in business strategies, as well as the establishment of sustainability-related metrics. These metrics may be linked to the company’s sustainability targets or performance. Other potential measures include variable remuneration policies and targets for bonuses which include non-financial targets, such as sustainability factors.
Sustainability expertise on boards of directors
Furthermore, the European Commission is considering what actions boards of directors will need to take to enhance their sustainability expertise. Examples of such actions include regularly assessing their expertise level on environmental, social and/or human rights matters and taking appropriate follow-up.
Another possibility being considered is a requirement on a number or percentage of directors to have environmental, social or human rights expertise.
For questions, please contact Michelle Krekels.