EU Corporate Sustainability Due Diligence Directive

This update follows on from earlier pieces about the inception of the European Union’s (EU) corporate sustainability agenda and the institutions’ progress on this issue as of April 2022.

In 2013 the collapse of the Rana Plaza garment factory in Bangladesh killed over one thousand workers who manufactured clothes for many major U.S. and European brands. A little over ten years later, the EU’s efforts to strengthen corporate due diligence and prevent a repeat of that tragedy are now on the cusp of succeeding. On 1 June 2023, the European Parliament will most likely support a legislative text that will then be confronted to the Commission and Council’s positions. The objective being to finalize legislation that satisfies everyone before the upcoming EU parliamentary elections of 2024.

Three-way conversations

The European Parliament’s text is the result of hard-fought sessions in its Legal Affairs Committee that truly took onboard most political groups’ positions. This explains why the text is expected to pass the 1 June vote and be the basis of the Parliament’s position in the following months’ ‘trilogues’. During these trilogues, the European Parliament, European Commission, and European Council will confront their respective positions on corporate due diligence and negotiate to reconcile points of disagreement. The aim of the process will be to produce a single piece of European legislation on the issue.

There are three main sticking points that need to be ironed out in the trilogues. Firstly, the three European institutions disagree on who exactly should be targeted by the planned measure. Compared to the Commission and Council, the European Parliament seeks to expand the scope of the due diligence rules so that they apply to all EU companies with more than 250 employees and a net worldwide turnover of more than €40 million. The Parliament also wants to subject “ultimate parent companies” of a group with 500 employees and a net worldwide turnover of over €150 million to due diligence obligations. At the other end of the spectrum, the Council’s position envisions that the rules would only initially apply to very large companies that have more than 1000 employees and €300 million net worldwide turnover.

Scope of responsibilities

The second major sticking point concerns the types of activities for which companies would be held liable. In the proposal it put out in February 2022, the Commission intended the new framework to apply to companies’ “value chain”. While such a concept would capture all of a companies’ activities, both upstream and downstream, the Commission somewhat restricted the scope of their proposed text by only addressing activities conducted in the context of “established business relationships”. The Council found the “value chain” concept too broad and chose instead to focus on “chain of activities”, which would significantly limit the obligations on companies to investigate the downstream part of their value chain.

For their part, the Members of the European Parliament accepted the Commission’s “value chain” concept but also decided to limit companies’ downstream obligations by excluding the “use” of their products and services from the scope of the rules. This exclusion places the Parliament on a collision course with civil society organizations that were already disappointed by the Commission’s focus on “established business relationships” but vindicates business associations that worried that the “value chain” concept exposed EU companies to unforeseeable liabilities.

The third major sticking point between the three EU institutions concerns the possible inclusion of the financial sector. The Commission’s initial proposal included the financial sector and Justice Commissioner Dider Reynders had insisted on the idea that due diligence obligations apply across all sectors. On the contrary, the European Council, under the impulse of France, pushed to leave the inclusion of the financial sector up to individual member states.

The European Parliament seems to have taken the middle road with the Legal Affairs Committee agreeing to include “asset managers and institutional investors” but not “pension funds, alternative investment funds, market operators and credit rating agencies”. The status of the financial sector is likely to be a key point of contention in the trilogues. Civil society organizations have emphasized the importance of its inclusion to guarantee the success of the EU’s entire due diligence framework. On the other hand, organizations like the American Chamber of Commerce worry that such an inclusion would expose transactions “without any EU nexus at all” to Brussels’ scrutiny.

Conclusion

The EU’s planned due diligence rules remain a divisive issue, especially in business circles. In addition to foreign companies’ concerns about extraterritoriality, some European politicians like Czech Renew MEP Martina Dlabajová have warned about the “end of free enterprise”. However, several world-leading businesses are also supportive of the EU’s efforts. As late as April 2023, several companies including Danone, Ikea, and Unilever called on Brussels to adopt an ambitious framework “including downstream, in all sectors, including financial institutions”. And civil society organizations are pushing for the final text to go even further than any of the three institutions’ positions. They consider that even the European Parliament “stops just short of real justice”, notably unhappy with MEPs’ insistence that victims of corporate due diligence failures shoulder the burden of proof to demonstrate wrongdoing.

The Council, Commission, and Parliament are operating on a relatively tight schedule. Unless the measure is passed by next summer, the June 2024 European parliamentary elections will cause the whole process to stall for months, or even years. Hungary’s July 2024 presidency of the Council could act as an additional road bump. So, despite significant divergences, EU institutions must put their head down in the upcoming months to ensure that Europe doesn’t miss the opportunity to become a trend-setter on this vital issue. Given the gap between pro-business voices and civil society organizations, the Parliament’s middle-ground position might be a good compromise. It balances competing interests well while ensuring that the original intention of the entire initiative, to prevent a repeat of the Rana Plaza disaster, endures in the final directive.