ESG in the EU: key legislative developments

While the EU has, until recently, heavily focused on the “E” of ESG, the S and G are gaining increasing traction.

Following on from the first article regarding the ESG framework in the EU, this article will consider the key legislative developments in this space.

ESG in the supply chain started to emerge as a major theme in 2022, with businesses coming under increasing pressure to identify and address human rights, environmental and governance risks in their value chains.

In practice, this means that businesses must seek greater visibility of their suppliers’ operations and ensure certain environmental, human rights and governance safeguards, including driving ESG commitments into their supply contracts. This in turn means that all stakeholders in the supply chain are (at least indirectly) affected by related sustainability laws.

This change is driven by a transition from soft law standards, such as the UN’s Guiding Principles on Business and Human Rights, to hard law obligations.

There is also an expansion of expectations: the new generation of sustainability laws requires qualifying businesses to actively address adverse impacts on human rights and the environment (and possibly governance factors) in their value chains instead of just having to identify and report on environmental impact at best.

The key pieces of legislation which have or are being introduced are:

1. Deforestation risks

The recently adopted EU Deforestation Regulation (EUDR) imposes extensive due diligence obligations on the value chain for all operators and traders dealing with certain products derived from cattle, cocoa, coffee, oil palm, rubber, soya and wood.

Businesses who fall in scope will need to undertake due diligence to ensure commodities placed on the EU market are “deforestation-free”, meaning they must not have been produced on land deforested or degraded after 31 December 2020 (regardless of whether the deforestation or degradation was legal under local laws).

To ensure that items entering the EU market are not from land in scope, operators and non-SME traders will need to:
1. Collect detailed information that demonstrates the products comply with the EUDR;
2. Carry out a risk assessment in relation to each product to ascertain the risk of non-compliance with the EUDR; and
3. Mitigate risks by carrying out independent surveys/audits, gathering additional documentation, or working with suppliers (particularly SMEs) through capacity building and investments.

The EUDR also requires operators to establish and maintain a ‘due diligence system’ of procedures and measures to ensure relevant products are compliant.

In general terms, penalties must be effective, proportionate and dissuasive. It will be on EU member states to decide the applicable penalties for a breach of the EUDR (entering into force shortly), including confiscation of the items and related revenues, fines proportionate to the environmental damage (at least 4% of the relevant entity’s annual EU-wide turnover), temporary exclusion from the public procurement process and temporary prohibition from placing relevant commodities or products on the market.

2. Supply Chain Due Diligence via the Corporate Sustainability Due Diligence Directive (CSDDD)

The Commission’s proposal for a Corporate Sustainability Due Diligence Directive, if adopted in its current form, will introduce duties on companies with certain turnover/activity in certain high-impact sectors yet to be agreed (including certain non-EU businesses), to establish risk management systems to identify risks of human rights violations and damage to the environment (as well as possibly governance).

This includes integrating due diligence into all corporate policies, having a due diligence policy that is updated annually, and a code of conduct for the company’s employees and subsidiaries.

Where risks or actual violations or damage are found, the business must take appropriate steps to prevent, end or minimise those violations and damage. These obligations extend beyond a business’s own operations, to include certain business partners (the exact scope is yet to be agreed).

In addition, the CSDDD will make it mandatory for in-scope businesses to seek contractual assurances from their business partners that they will comply with the business’s code of conduct and, as necessary, any action plans introduced to prevent adverse human rights and environment impacts.

Suppliers will be required to seek corresponding contractual assurances from their own business partners.

It is worth noting in this context that even those UK businesses that are not directly in scope but trade with in-scope EU companies will therefore be asked to meet these requirements and provide related information/checks.

Certain companies must also have a plan to ensure that their business model and strategy are compatible with the transition to a sustainable economy and with limiting global warming to 1.5°C, in line with the Paris Agreement. It is yet to be agreed whether this obligation will apply to all in-scope companies.

Directors’ due diligence duties and whether achievement and remuneration of directors should be linked to their contribution to the company’s business strategy and long-term interest and sustainability are yet to be agreed. However, it seems certain though that the CSDDD will have a direct impact on company directors.

Sanctions for non-compliance include financial penalties as well as civil liability claims.

3. The Green Claims Directive

In March 2023, the Commission adopted a proposal for a Directive on Green Claims, which complements and further operationalises the proposal for a Directive on empowering consumers in the green transition.

To ensure consumers receive reliable, comparable and verifiable environmental information on products, the proposal includes clear criteria on how companies should prove their environmental claims and labels, requirements for these claims and labels to be checked by an independent and accredited verifier.

While complex and at times difficult to trace, the EU’s regulatory frameworks for sustainability are in line with the EU’s commitment to achieving the United Nations’ 2030 Agenda and Sustainable Development Goals and will continue to evolve to address emerging challenges and opportunities.

If you have questions about the EU’s ESG regulatory framework, please contact Alexandra von Westerhagen.