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ESG for startups by vestbee
09 September 2022·5 min read

Paulina Milewska-Mróz

Senior Associate, B2RLaw

ESG Due Diligence: New EU Requirements On Corporate Sustainability

As we continue on with the series breaking down the basics and intricacies of the importance of ESG factors for entrepreneurs and startup founders, it is time to shed some light on the new EU requirements regarding the sustainability of businesses. 

On 23 February 2022, the European Commission published a proposal for a Directive on corporate sustainability due diligence. The Commission noted that the European Union's transition to a climate-neutral and green economy and the achievement of the Sustainable Development Goals, including human rights and environmental goals, requires companies to implement comprehensive procedures to mitigate risks of adverse human rights and environmental impacts in their value chains. 

Certain companies in the EU have voluntarily implemented responsible business conduct standards. However, the European Commission's assessment is that voluntary measures have not led to widespread improvements in individual economic sectors. The fact that the EU economy is so heavily linked to the global economy results in EU businesses inadvertently also having business links with bad actors, which in turn negatively impact human rights and the environment. In particular, such negative impact includes violations of workers' human rights, such as forced labour, child labour, inadequate occupational safety and health protection and exploitation of workers, and are associated with negative environmental impacts through greenhouse gas emissions, pollution or leading to biodiversity loss and ecosystem degradation. Reducing the identified threats to human rights and environmental protection requires the adoption of appropriate regulations at the EU level.

The Directive aims to improve corporate governance practices by ensuring that processes for managing and mitigating human rights risks, environmental risks and impacts, taking into account risks and impacts arising from value chains, can be more effectively integrated into companies' strategies. The aim is also to avoid fragmentation in the due diligence process. This may be ensured through the implementation of uniform rules providing for legal certainty on the one hand, and making companies more accountable for the adverse impacts of their activities on the other hand. Furthermore, the Directive aims to improve access to remedies for those affected by adverse human rights and environmental impacts resulting from companies' activities.

The new due diligence rules will apply to both EU and third country businesses. With regard to EU companies, the rules anticipate two groups of companies:

  1. all EU companies with limited liability, of significant size and economic power (with more than 500 employees and a global net turnover of more than € 150 million) (Group 1);
  2. other EU companies with limited liability in defined high-impact sectors that do not meet the criteria of Group 1 but have more than 250 employees and a global net turnover of more than € 40 million (Group 2).

In terms of third-country companies, the Directive also distinguishes between two groups:

  1. third country undertakings which have recorded net sales in the Union of more than EUR 150 million in the financial year preceding the last financial year (Group 1);
  2. other third country undertakings which have recorded net sales in the Union of more than EUR 40 million but not more than EUR 150 million in the financial year preceding the most recent financial year, provided that at least 50% of the net sales revenues worldwide were recorded in at least one high-impact sector (Group 2).

For Group 2 companies from the EU and third countries, the rules will take effect two years later than for Group 1 companies.

The Directive envisages that companies will have to:

  1. integrate due diligence into their policies,
  2. identify actual and potential negative impacts on human rights and the environment,
  3. prevent or mitigate potential impacts,
  4. eliminate or minimise actual impacts,
  5. establish and maintain a complaints procedure,
  6. monitor the effectiveness of due diligence policies and measures,
  7. publicly report on due diligence.

Additionally, Group 1 companies will be required to adopt a plan to ensure that the company's operations and strategy are consistent with the transition to a sustainable economy and the goal of limiting global warming to 1.5 °C, as set out in the Paris Agreement.

The Directive requires corporate management to establish and oversee the implementation of corporate sustainability due diligence processes and measures and to align corporate strategy with them. 

Enforcement of the new rules will be the responsibility of national administrative authorities designated by Member States. These authorities will be able to impose penalties in case of non-compliance. In addition to that, victims of human rights and environmental violations will be able to sue for compensation for damages that could have been avoided through appropriate due diligence measures. The provisions on the duties of the management boards will be enforced by the relevant laws of the Member States.

A proposal containing a draft directive will be submitted to the European Parliament and the Council for approval. Once the Directive has been adopted, Member States will have two years to transpose it into national law and to transmit the relevant texts to the Commission.

Related Posts:

ESG For Startups: Re-defining The Supply Chain (by Julia Pycka, Associate, B2RLaw)

How To Outperform The Competition With ESG? (by Agnieszka Hajos-Iwańska, Partner, B2RLaw)

How To Improve ESG Metrics In Your Startup? (by Julia Pycka, Associate, B2RLaw)


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