Recent EU Initiatives Focus on Sustainability, Forced Labor

At the EU level, three significant texts aimed at reinforcing environmental, social, and governance (ESG) compliance among corporations are currently being drafted: a proposed directive to implement and strengthen corporate reporting obligations relating to human rights and the environment; a proposed directive to create an EU legal framework on sustainable corporate governance, including cross-sector corporate due diligence along global value chains; and a proposed regulation to prohibit products made with forced labor on the EU market.

CORPORATE SUSTAINABILITY REPORTING DIRECTIVE (CSRD)

Purpose

On 21 April 2022, the European Union put forward a proposal for a corporate sustainability reporting directive (CSRD)[1] to revise and strengthen the existing rules introduced by the Non-Financial Reporting Directive (NFRD) on sustainability reporting. The CSRD will make sustainability reporting by companies more consistent, so that financial firms, investors, and the broader public can use comparable and reliable sustainability information.

Scope

The scope of the CSRD will be wider than the NFRD because its obligations will concern both of the following:

• Companies exceeding the limits of least two of the three following thresholds:
  • Balance sheet total: €20,000,000
  • Net turnover: €40,000,000
  • Average number of employees: 50 employees
• Listed companies, including small and medium-sized enterprises (SMEs); proportional reporting rules may apply depending on their size.

In practice, nearly 49,000 companies will be affected by this new financial reporting obligation (compared to 11,600 companies under the NFRD). Unlisted SMEs will be able to publish the same information on a voluntary basis.

In addition, the CSRD will also directly affect the following:

• Companies not established in the European Union that are listed on an EU-regulated market
• Non-EU companies that satisfy these two cumulative criteria:
  • A net turnover exceeding €150,000,000 in the European Union
  • At least one subsidiary or branch in the European Union

Main Obligations

The CSRD will impose binding assessments on companies in terms of sustainability and financial performance.

Covered companies must include, in a specific section of the management report, the information necessary to understand the company’s impacts and position on sustainability matters, including descriptions of the following:

• Its business model, strategy, policy, and targets related to sustainability matters, as well as the progress it has made toward achieving those
• Its organizational structure as it relates to sustainability issues, the principal risks related to sustainability matters, and how it manages those

The management report must also include details concerning the company’s value chain: its structure should be detailed, including the inherent risks in terms of sustainability. It should also indicate the actions taken to prevent, mitigate, or remediate actual or potential adverse impacts, and the results of such actions. The company will have to account for its entire value chain, even if it extends to countries outside the European Union.

The CSRD will requires a statutory auditor to perform a limited assurance mission on a company’s sustainability reporting, including on the following:

• Compliance of the sustainability reporting with the reporting standards
• Process carried out by the company to identify the information reported pursuant to the standards
• Markup of sustainability reporting and the indicators reported

Penalties for noncompliance with these provisions will, however, remain determined by the EU member states, but the penalties must be sufficiently proportionate and dissuasive.

Expected Entry into Force

The CSRD is expected to enter into force in January 2023, but it can take up to two years for member states to transpose its provisions into their national legislation.

CORPORATE SUSTAINABILITY DUE DILIGENCE DIRECTIVE (CSDDD)

Purpose

On 23 February 2022, the EU Commission adopted a proposal for a directive on corporate sustainability due diligence, amending Directive (EU) 2019/1837.[2]

The proposed CSDDD will set out a horizontal framework for businesses operating in the EU market to promote human rights and environmental considerations in their own operations and through their value chains by identifying, preventing, mitigating, and accounting for their adverse human rights and environmental impacts, and having adequate governance, management systems, and measures in place to this end.

Scope

Its obligations will concern EU companies with:

• More than 500 employees and €150 million of net worldwide turnover (EU group 1)
• More than 250 employees and €40 million of net worldwide turnover if at least 50% of such turnover is generated in one of the following sectors (EU group 2):
  • Manufacturing of textiles, leather, and related products
  • Agriculture, forestry, fisheries, and manufacturing of food products
  • Extraction of mineral resources (including petroleum, natural gas, coal, metals), manufacturing of basic metal products, and wholesale trade of mineral resources

The obligations also affect non-EU companies with:

• €150 million of net turnover in the European Union (non-EU group 1)
• €40 million of net turnover in the European Union if at least 50% of such turnover is generated in one of the above-mentioned sectors (non-EU group 2)

The approximate amounts of affected companies follow:

• EU group 1: 9,400
• EU group 2: 3,400
• Non-EU group 1: 2,600
• Non-EU group 2: 1,400

Main Obligations

Obligations

Covered companies must conduct human rights and environmental due diligence by carrying out the following actions:

• Integrate due diligence into their corporate policies. The policy must contain (1) a description of the company’s approach to due diligence, (2) a code of conduct describing rules and principles to be followed by the company’s employees and subsidiaries, and (3) a description of the processes put in place to implement due diligence obligations.
• Identify actual and potential adverse impacts on human rights and the environment arising from their own operations and, where related to their value chains, from their established business relationships.
• Prevent or mitigate potential adverse impacts. Covered companies must, notably, adopt a prevention plan or seek contractual guarantees that direct and indirect business partners will comply with the company’s code of conduct. When a potential adverse impact could not be prevented or adequately mitigated, the company shall refrain from entering into new or extending existing relations, suspending contracts, or ending relationships.
• Stop or mitigate actual adverse impacts, in particular by paying damages to affected persons/communities, implementing corrective plans, obtaining contractual guarantees from direct and indirect business partners, or making the necessary investment into management or production processes.
• Conduct a yearly assessment of operations and established business relationships (where related to value chains) to monitor the effectiveness of identification, prevention, mitigation, and resolution of the adverse impacts.
• Publish on its website a description of its due diligence, potential and actual adverse impacts, and actions taken thereon.

The Commission will adopt guidance about voluntary model contract clauses to facilitate compliance with these obligations.

Sanctions

Concerning public enforcement, supervisory authorities will be established in each EU member state to carry out investigations, order the cessation of infringements, impose fines, and adopt interim measures. The sanctions (which will be determined by each member state) shall be effective, proportionate, and dissuasive. Pecuniary sanctions shall be based on the company’s turnover.

Concerning private enforcement, member states shall set up rules governing the civil liability for a company’s failure to comply with the obligation to prevent, mitigate, or cease adverse impacts if, as a result of this failure, an adverse impact that should have been identified, prevented, mitigated, or resolved occurred and led to damage.

This civil liability regime may, however, vary depending on the member state concerned.

Expected Entry into Force

The timeline for final adoption of the CSDDD is still unclear, but an approximate entry into force could be estimated as 2025 (plus the time for the member states to transpose the provisions into their own legislation).

PROHIBITING PRODUCTS MADE WITH FORCED LABOR ON THE UNION MARKET REGULATION (PPMFLR)

Purpose

On 14 September 2022, the EU Commission adopted a proposal for a regulation prohibiting products made with forced labor on the EU market.[3] “Forced labor” is defined by the International Labour Organization (ILO) as “all work or service which is exacted from any person under the threat of a penalty and for which the person has not offered himself or herself voluntarily.”

The objective of this proposal is to effectively prohibit the placing and making available on the EU market, and the export from the European Union, of products made with forced labor.

Scope

The Regulation will apply to any product made available on the market by an economic operator. The prohibition covers domestically produced (for the export or not) and imported products, including their components, without targeting specific companies or industries.

Main Obligations

Economic operators shall not place or make available on the EU market products that are made with forced labor, nor shall they export such products.

In order to implement this obligation, a competent authority should assess the likelihood that economic operators are in violation based on assessments that may be undertaken by legal or natural persons, international organizations, or a future database of risk areas.

Investigations by Competent Authorities

Economic operators can be the subject of investigations. In this case, the economic operator will have to communicate any information that is relevant and necessary for the investigation, including information identifying the manufacturer or producer of the product and the product supplier.

Before initiating an investigation, competent authorities shall request from the economic operator information on actions taken to identify, prevent, mitigate, or resolve the risk of forced labor in their operations and value chains with respect to the products under assessment (the economic operator shall respond to the request within 15 working days).

If competent authorities determine that there is a substantiated concern of a violation, they shall initiate an investigation. Competent authorities may carry out all necessary checks and inspections including investigations in third countries, provided that the economic operators concerned give their consent and that the government of the third country in which the inspections are to take place has been officially notified and raises no objection.

Decision of Competent Authorities

If a violation is established, any of the following actions may be taken:

• A prohibition to place or make the products concerned available on the EU market and to export them
• An order to withdraw from the EU market the relevant products that have already been placed or made available on the EU market
• An order to dispose of the respective products

The economic operator may request a review of that decision within 15 days.

Customs Jurisdiction

A product can be suspended or retained where Customs identifies a possible violation. Competent authorities are immediately notified. A product is released within 4 days if the competent authorities have not requested to maintain the suspension, or when the competent authorities inform Customs of their approval for release.

When the competent authorities conclude that a product is made with forced labor, they require Custom not to release it nor to allow its export, and the product should be disposed of or destroyed.

Sanctions

It is up to the EU member states to lay down the rules on penalties for noncompliance with a decision from the competent authorities to place, withdraw, or dispose of the concerned product. The penalties shall be effective, proportionate, and dissuasive.

Expected Entry into Force

The timeline for the final adoption is still unclear, but an approximate entry into force could be estimated as 2025.