Mandatory due diligence in the EU: new developments, legislation and how to prepare companies

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Giulia Borsa

The European Union (EU) is moving towards mandatory supply chain due diligence. On February 23, the European Commission adopted the first proposal for such a procedure on corporate sustainability. The aim of this Directive is to promote sustainable and responsible business behavior and to anchor human rights and environmental considerations in the operations and corporate governance of companies.

Some countries have already implemented a number of due diligence preparation initiatives or even have such a mechanism in place.

Developing a due diligence program from scratch or adapting existing policies to legislative changes requires relationship building, knowledge of the supply chain and, above all, time. However, there are certain steps companies can take immediately to be prepared.

Due Diligence Obligations

This Directive establishes a duty of due diligence for companies. The core elements of this are to identify, stop, prevent, mitigate and account for negative impacts on human rights and the environment in the company's own operations, its subsidiaries and its value chains. In addition, certain large companies need to have a plan to ensure that their business strategy is compatible with limiting global warming to 1.5°C in line with the Paris Agreement. Directors have incentives to contribute to sustainability and climate change mitigation goals.

The Directive also introduces duties for directors of EU companies with such an obligation. These duties include establishing and overseeing the implementation of due diligence processes and integrating due diligence into corporate strategy. In addition, in fulfilling their duty to act in the best interests of the company, directors must take into account the consequences of their decisions on human rights, climate change and the environment.

Stakeholders concerned by due diligence

The companies that must account for this report are as follows:

Large EU limited liability companies:

- - Group 1: +/- 9,400 companies with more than 500 employees and more than 150 million euros net sales worldwide.
  - Group 2: +/- 3,400 companies in high impact sectors. More than 250 employees and a net turnover of more than 40 million euros worldwide, and operating in defined high impact sectors, textiles, agriculture, mineral extraction. For this group, the rules start to apply two years later than for group 1.

Companies outside the EU: +/- 2,600 companies in Group 1 and +/- 1,400 in Group 2
Third country companies active in the EU with turnover threshold aligned with Group 1 and 2, generated in the EU.

Microenterprises and SMEs are not affected by the proposed rules. However, the proposal provides for support measures for SMEs, which could be indirectly affected.

Preparing to meet reporting requirements

Despite the uncertainty about the timing of implementation in Spain of this new requirement, there are immediate steps that companies can take now to prepare. Building close relationships with suppliers will enable a number of due diligence assumptions to be met, be it risk analysis, stakeholder engagement or reporting channels.

Practitioners can start by better understanding the actors in their supply chain and identifying their respective social and environmental risks. Companies are also looking to lay the groundwork for a robust reporting system that includes the processes for collecting information from their suppliers. Through early action, organizations can prepare their business partners to provide the necessary data at the time when due diligence requirements become legally binding or existing legislation is extended. The proposal will now go to the European Parliament and the Council for approval. Once adopted, Member States will have two years to transpose the Directive into national law and communicate the relevant texts to the Commission. It is therefore recommended that companies that are in the future obliged to implement such a mechanism carry out a prior risk analysis with an environmental and social assessment of the stakeholders and business partners involved in the business.